Archive for the ‘Risk Management’ Category

When Common Sense Is Senseless

Friday, December 6th, 2013

What was I thinking?

Over the past couple of years, I’ve preached caution.  Corporate profits were down and unemployment was up.  The economy wasn’t growing, but the federal debt was.  Iran was developing nuclear capabilities while the entire continent of Europe was going bankrupt.  And investors were still shell shocked from the 2008 financial meltdown.

Not a good time to invest in stocks.  Not a good time to invest, period.  Common sense dictated restraint.Bungee Jumping

And the federal government’s answer was to spend as much as possible, while printing more money and buying more bonds than at any time in history.  After record stimulus spending and $4 trillion in bond buying, common sense would suggest high inflation and a sagging stock market; a good time to invest in gold and other hard assets.


Pick One: High Risk or Low Returns

Monday, May 2nd, 2011

Here’s your choice: Take on lots of risk and hope for the best or watch your standard of living erode.

The stock market has been soaring, thanks to the Federal Reserve Board’s quantitative easing program, which has continued to hold interest rates at or near record lows for several years now.

Investors came back into the market, not because the market was showing signs of strength, but because it became the least objectionable place for investors to put their money.

A 12-month certificate of deposit (CD) is yielding 1.25% interest today.  The U.S. inflation rate rose to 2.7% in March and is continuing to rise – a deliberate outcome of Fed policy.  So the real rate of return, in exchange for tying up your money for a year, is negative 1.45% (2.7% – 1.25%).

Conversely, The Russell 2000 Index of small-cap stocks recently hit a new high, having jumped 150% since March 2009, including a 9.5% gain so far for 2011.

Small-cap stocks are, of course, the riskiest stocks, representing companies with market capitalizations of $2 billion or less.  And the higher small-cap prices soar, the riskier they become and the more likely it will be that we will see a market correction.

What will happen when quantitative easing ends?  What will happen when market conditions, rather than Fed programs, dictate returns?

“Buy and Hold” Is NOT “Still A Winner”

Thursday, November 18th, 2010

Investors are being advised by Princeton Professor Burton G. Malkiel (“ ‘Buy and Hold’ Is Still A Winner”) to hang in there, even when the market drops 60% of its value, as it did during 2008-2009.

But Professor Malkiel clearly has little understanding of active investment management, a valid alternative to “buy and hold” investing, which he equates to market timing.

Active investment managers use technical and fundamental research to drive their decision making.  Active managers aim to reduce volatility and draw downs by using proven techniques such as hedging and stop-loss orders, as well as some of the techniques he advocates in his column – diversification, dollar-cost averaging.

The big difference is that active managers sell off when they see trouble coming.  Advising my clients to sell in the summer of 2008 saved them a great deal of money that they would have lost if they followed the “buy and hold” strategy (see The Wall Street Journal, Feb. 12, 2009 for an example from Wenning Investments).

Professor Malkiel advises individual investors to keep their money in index funds and ignore the ups and downs of the market.  He cites respected investors Warren Buffett and Yale’s David Swenson, who give the same advice.

But if investing in index funds is such a great idea, why don’t Mr. Buffett and Mr. Swenson follow their own advice?  Active investment managers believe individual investors should benefit from many of the same techniques that these investment experts use.  If we’ve learned anything from the past decade, we should have learned that investing in index funds is too risky.

Fixed-Income Investors Weather Sovereign Debt Crisis

Monday, May 10th, 2010

Because of our focus on managing risk, fixed-income clients of Wenning Investments generally fared well during last week’s sovereign debt crisis, even though it created widespread panic in global markets around the world. 

Clients who hold a short bond position (TBT, PST) saw an unfavorable drop in prices, but we believe that the drop is temporary.  The position is held to provide a hedge against rising interest rates.  Interest rates fell last Thursday, but the overall trend is for interest rates to rise.

Other bond holders benefited from a decline in yields, which made the bonds they hold more attractive, since bond prices moved higher during the flight to safety.

During times of uncertainty, investors buy bonds to add protection to their portfolios and to avoid losses from falling stock prices.  When that happens, bond yields are driven lower, because the demand for bonds outweighs the supply.

Thursday, during the flight to safety, the 10-Year Treasury yield fell to 3.24%, down from 4% last month.  Today, though, the yield is inching back and is at 3.56%.

According to The Wall Street Journal, “The European Union agreed on an audacious $955 billion bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece.”

This agreement has calmed fears around the globe and global stock markets are trending higher on the news.

Bust-Proof Investing For Boomers

Wednesday, March 31st, 2010

We’ve been focussing on the “senior bust” that many baby boomers will face as they approach retirement. 

So how can baby boomers avoid the senior bust?

The starting point is to understand your finances.  You’ll need to know your current assets and have a good idea of how much you’ll need to live off during retirement.  Assuming your current retirement is not adequate, you’ll need to save more and invest wisely.

Some alternatives include:

Delay retirement.  The longer you work, of course, the more you can save and the longer it will be before you need to draw off of your retirement funds.  Assuming your children are grown and your expenses are minimal, you can probably save a great deal more for retirement than you could when you were younger.

Delay Social Security.  Annual cost-of-living increases are calculated using the initial year’s Social Security income as a base, so delaying the start of Social Security for even a few years can raise annual income significantly.  While individuals are eligible for Social Security at age 62, they must wait until age 65 if they want “full” benefits (67 for those born in 1960 or later) and age 70 if they want “delayed” benefits.

Manage risk.  Keep in mind that what your investments earn from day to day or even year to year is not nearly as important as what they earn long term.  Most investors concentrate on short-term returns and don’t spend enough time focusing on avoiding losses.

An investor or investment manager can do much to avoid risk, without sacrificing growth.  A few examples include:

  • Diversify.  Virtually anyone who manages investments recommends that investors invest in a mix of many different types of investments.  For example, the stock portion of an investor’s portfolio may include growth and value stocks; small-cap, mid-cap and large-cap stocks, and international and domestic stocks.
  • Pay attention to the market.  Using technical as well as fundamental analysis can alert investment managers about potential market changes.  Adjusting your portfolio based on these potential changes can help minimize losses.
  • Use stop losses.  Stop losses are used to automatically sell securities when they drop to a certain price.  This allows investors to avoid potentially large losses.
  • Consider convertibles.  Convertible securities combine features of both stocks and bonds.  The income they produce provides downside protection.  In addition, they are typically not as volatile as stocks.

Of course, among the worst mistake investors can make is to sell their stocks when the market is bottoming out.  “Selling low” is also among the most common mistakes investors make.  Those who sold a year ago because they couldn’t tolerate any more losses should learn from their mistake and hopefully will avoid selling at the tail end of the next bear market.