According to a Fidelity study among 200 financial advisors during the second quarter of 2014, managing risk was their greatest concern, ahead of managing portfolios and fixed income challenges. During the same survey from first quarter, managing risk was the third most worrisome factor among advisors, indicating increased angst surrounding market volatility as of late.
“We believe that the differences between winners and losers among asset classes and individual securities are likely to increase, favoring active asset managers with the ability to conduct the research necessary to identify those opportunities offering the best chances for growth,” said Scott E. Couto, president, Fidelity Financial Advisor Solutions.
With the Federal Reserve scaling back its bond stimulus and speculation that short-term interest rates, which have remained near zero since December 2008, will rise sooner than expected, investors are worried about a markets correction.
A correction is defined as a 10% drop in a major stock index. The Fed’s easy money policies have been a boon to stocks over the past few years. The Fed's exiting the picture is worrying some investors.
“Risk is the most important part of money management from a portfolio return perspective and from a meeting client expectations perspective,” says Jeff Raupp, CFA and senior investment manager at Brinker Capital.
Investing is just as emotional as it is quantitative. Plenty of investors panicked following the financial crisis of 2008 and subsequently in March 2009 when the Dow Jones Industrial Average dipped into the 6,500s, an all-time low. The Dow is up 150% since then, and anyone who sold during the lows missed out on the market’s epic recovery.
Bill Peattie, founder of Peattie Capital Management, says he talks to clients about the rule of 72, a classic investing concept which helps determine how long it takes to double your investment. Simply divide 72 by the rate of return each year, and that outcome is the number of years it’ll take to double your principal.
“This helps clients get a handle on what they might expect,” Peattie says. “That there will be bumps along the way and this helps them see the bigger picture.”
For other money managers like Bill Ferrell, president and chief investment officer of Ferrell Capital Management, taking cues from what the market says is key to managing risk.
“Our starting place is to allocate risk not assets,” he says. “This means we allocate the amount of risk we want to put in each asset class and then fill up each class with money, which is the opposite of how most managers operate.”
Ferrell says his firm tracks risk each day to get a movie, not a picture, of what is going on in the marketplace.
“The market is going to tell us whether people are really worried about the current environment and you’ll see that reflected in volatility measures and how fast stock prices change,” Ferrell adds.
- Written by Scott Gamm for MainStreet. Gamm is author of MORE MONEY, PLEASE.