Commentary
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Volume 19: 1st Quarter 2012
Editor's Note: Volatility was the watchword this past summer so it's not surprising that two different professionals asked to share their perspectives on this important topic in this issue. Since this is something we can't have too much of, I am printing them both.
Take Two Aspirin and Rebalance in the Morning
Evaluating risk and opportunity.
Market volatility has increased significantly in recent months, leading many investors to question their investment strategies. In part, this is driven by a dramatic increase in high-frequency trading, which is based on computer algorithms rather than fundamental analysis. It is thought that high-frequency trading accounts for 60-70% of trading volume today and can accelerate trends both up and down. Seeing rapid swings of several hundred points in either direction, day in and day out, can shake the confidence of even the most seasoned market participant.
Human nature poses one of the most serious threats to long-term investment success with points of maximum fear typically signaling market bottoms and euphoria peaking near market tops. As Warren Buffett famously said, “Success in investing doesn’t correlate with IQ once you get above the level of 125. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble investing.” Truer words have never been said!
Mutual fund flows provide great insight to investor behavior. Not surprisingly, mutual fund inflows tend to be strongest as markets are hitting highs, and outflows are usually greatest near market lows. Dalbar Inc., a market research firm that has studied mutual fund investor performance against various indexes for years, concludes, “Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who time the market.” Recently we have seen funds flow out of stock funds and into bond funds as volatility in the stock market has increased and interest rates hover at all-time lows.
It has always been surprising to me that most of us love buying merchandise on sale, but hesitate to buy various investments when they are at a discount. In fact, we do just the opposite. Markets bottom on headlines of doom and gloom and peak on headlines focused on strong economic outlooks and a bright future. While it can be quite a challenge to tune that noise out, it is essential for investment success.
Having a well-diversified portfolio often makes it easier to ride out volatile times. Our increasingly global economy has led to much greater correlation between equity markets, whether they be domestic or international, large or small. It is essential to include non-correlated assets such as fixed income and perhaps even a commodity and/or real estate component as part of your portfolio to smooth out returns.
The most important thing is to have a plan. An asset allocation appropriate for your financial situation, risk tolerance and age is key, and then it is important to have the discipline to stick to it. Let volatile markets work in your favor, allowing you to buy things on sale when others are panicking and pulling their money out and to take a little money off the table when others are clamoring to buy. As John Maynard Keynes long ago opined, “It is largely the fluctuations which throw up the bargains and the uncertainty due to fluctuations which prevents other people from taking advantage of them.” First Republic Private Wealth Management stands ready to help you take advantage of these opportunities.
Disclaimer/Disclosure: First Republic Private Wealth Management encompasses First Republic Investment Management (“FRIM”), First Republic Trust Company (“FRTC”) and First Republic Securities Company, LLC (“FRSC”), Member FINRA/SIPC. FRIM is a SEC Registered Investment Advisor. This document is for information purposes only and is not intended as an offer or solicitation, or as the basis for any contract to purchase or sell any security, or other instrument, or to enter into or arrange any type of transaction as a consequence of any information contained herein. All analyses and projections depicted herein are for illustration only, and are not intended to be representations of performance or expected results. The results achieved by individual clients will vary and will depend on a number of factors including prevailing dividend yields, market liquidity, interest rate levels, market volatilities, and the client’s expressed return and risk parameters at the time the service is initiated and during the term. Past performance is not a guarantee of future results. Investors should seek financial advice regarding the appropriateness of investing in any securities, other investment or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Although information in this document has been obtained from sources believed to be reliable, we do not guarantee its accuracy, completeness or fairness, and it should not be relied upon as such. This document may not be reproduced or circulated without our written authority. The investment services and products mentioned in this document may often have tax consequences; therefore, it is important to bear in mind that FRIM does not provide tax advice. The levels and bases of taxation can change. Investors’ tax affairs are their own responsibility and investors should consult their own attorneys or other tax advisors in order to understand the tax consequences of any products and services mentioned in this document. Products and/or services offered by First Republic Securities Company, LLC, and First Republic Investment Management are not deposits or obligations of, or insured, guaranteed or endorsed by any bank, Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other agency, entity or person. The purchase of securities involves investment risks including the possible loss of principal.
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