Posted by: Thomas F. McKeon, CFA on November 5, 2020
It’s a question never far from the minds of many investors—especially this year of global pandemic, election, economic distress, civil unrest, weather events and the like.
Without sounding too glib, the short answer is—wait for it—NOTHING.
Of course that presupposes that one has an institutional-quality portfolio, broadly diversified and properly allocated across all appropriate asset classes in the appropriate proportions to achieve one’s stated goals over one’s time horizon within one’s risk budget—a big presupposition indeed.
Here is the reason why: trying to make and execute investment decisions in the short-term randomness and volatility of unsettled markets is a decidedly sub-optimal undertaking—and is likely to result in significant actual and opportunity costs—otherwise known as investment returns.
The Timeless Truth about prudent, fiduciary investing is simply this: portfolios should be allocated so that an investor can endure the worst the markets deliver without taking defensive action. This allows the investor to avoid making self-inflicted, “get-me-out”, emotion driven decisions that are universally destructive of portfolio value and returns.
Staying in the game also allows investors to fully reap the rewards of the inevitable rally that follows a market decline. The pandemic selloff of 1Q-2020 was as nerve-rattling as any period I have endured in the markets—testing every client’s breaking point. As an investment advisor I talked more than a few clients off the metaphorical “ledge.” I also had one or two that let emotions overwhelm them and they made very unfortunate defensive decisions.
The unexpected rally that commenced in 2Q-2020 which continued through September 2020 brought markets—and portfolios that remained invested—back to all-time highs. Those that panicked failed to participate fully or partially in a 50% rally in the S&P 500…an opportunity cost that can never be re-captured.
Structure IS the Strategy
Capturing market returns as efficiently as possible is the essence of optimized, fiduciary investing. Any departure from that simple premise is a step towards greater cost, greater risk, greater shortfall risk and greater outcome uncertainty.
Prudent, optimized investing reduces to this simple proposition: Assembling the right mix of market exposures—exposures that can enhance returns, mitigate risk or both—in the right proportions and the appropriate liquidity for your particular return and risk profile, and accessing them through the appropriate accounts/vehicles/products as cost effectively as possible.
Not Static or Simple
All of the above does not imply that portfolios are mindless, “set it and forget it” undertakings. As markets are dynamic, valuations fluctuate and asset class weightings need to be rebalanced. Individual opportunities and investment themes worth pursuing arise occasionally. Client circumstances change over time. Expected return and risk profiles change. Economic environments change. Tax loss harvesting can be helpful.
Having said that—and assuming that one is properly allocated—it is axiomatically true that the fewer decisions one has to make is the most direct path to better outcomes and less portfolio friction from self-inflicted mistakes, trading costs, missed opportunities and taxable events.