The Best Market Move Right Now? Wrong Question…

The past 10 years provided a lesson in the potential value of staying in investment markets for the long run. Yet many investors during that period didn’t do nearly as well, because they made understandable but costly mistakes. They may have attempted to predict market movements, concentrated their portfolios in hot sectors at the expense of adequate diversification or let their emotions overrule the need for patience and discipline.

But history has underscored the virtues of taking the long view rather than being distracted by the chatter. In this interview, Christopher M. Hyzy, Chief Investment Officer for Bank of America Private Bank, walks through those lessons and discusses how investors can incorporate them into their financial strategy.

Can investment risk ever be avoided entirely?

Just in case you’d forgotten that investment risk and return go hand in hand, the sharp market volatility at the end of 2018 offered an excellent reminder. To be successful as an investor, you have to take calculated positions that will be influenced by future events you can’t anticipate. That means assessing which types of risk you want to assume —market risk, credit risk, interest rate risk, among others — and how much of each to take on. Then you have to consider how to best manage those risks in global capital markets that are constantly in flux. Volatility, or market fluctuation, carries a negative connotation but it’s inevitable and unavoidable, and temporary market declines are almost always part and parcel of long market rises. Every year since the 1980s, the S&P 500 Index has had, on average, a pullback of more than 10% and drops of 5% three times a year. ¹

Of course, knowing that kind of volatility is coming doesn’t make it easier to stomach. But your natural reactions to a turbulent market could cause problems. Those temporary setbacks may turn into permanent losses if you sell at market lows. Or you might become excessively risk averse and want to stay in cash. That can feel reassuring. But it could also mean losing opportunities for gains and coming up short in portfolio growth.

If markets always decline periodically, doesn’t it make sense to try to anticipate when prices will drop?

The temptation to avoid price declines is logical, but it can be difficult to spot market swoons in advance — and the stakes of not staying invested can be high. Asset prices tend to grind higher over the long term, while other forms of return, like dividends, buybacks and interest payments, add up. Moreover, big returns often happen on just a few trading days — and if you mistime your exit from the market, you risk not being there when prices begin to rise.

For most asset classes, the longer the holding period, the greater the probability that your returns will end up positive. This is especially true of riskier assets such as equities, which can be volatile over shorter time periods but have historically achieved positive returns if held for as long as 20 years. History implies that you should use time in the market, not timing the market, to your advantage.

What’s the best approach to managing risk?

To grow your wealth over the long term, taking risks is important — it matters just as much as minimizing big losses. A diversified portfolio with a mix of asset classes — stocks, bonds, cash, and so on — can help you spread your risks to make your portfolio potentially less vulnerable to a slide in one or two of those kinds of investments and more likely to help you meet your long-term investing goals.

But that positive effect could come at the expense of short-term underperformance. In any given year, some asset classes do well while others do poorly, and a diversified portfolio is likely to produce lower returns than the asset classes that are having the best year. Yet a proper diversification strategy should expose you to asset classes that can provide unique benefits you may have otherwise missed out on. History suggests, for example, that U.S. stocks can provide long-term capital growth, while fixed income may provide diversification plus income. In some cases for qualified investors, alternative investments may provide excess returns because of exposure to the “illiquidity premium” — not having immediate access to your money.

And even when a particular asset class has performed well historically - putting all your money in that asset class can subject you to large drawdowns that can be difficult to handle for some investors. Adding fixed income to a portfolio can help reduce this risk while potentially enhancing risk-adjusted returns over the long term.

How can I stay disciplined and diversified over the long haul?

Over time, both your investing goals and your tolerance for risk over time are likely to evolve. So, it helps to have a plan that encourages not only discipline and evaluating your progress, but also the ability to mature as circumstances inevitably change.

Adhering to principles for long-term investing is a sophisticated process. Developing strategic asset allocation with a tactical allocation overlay, conducting due diligence when selecting investments, and prioritizing risk management are all key elements that, when done right, can help maximize your potential to reach your investment goals.