Turn it off…Like A Light Switch

Posted on March 14, 2016

Author Name By Troy Brown, CFA

Turn it off…

It’s a very catchy line from a show tune in the Broadway musical The Book of Mormon.  The show may be a little crass for some – probably even the majority – but within some of the more outrageous lyrics some sound advice can be found.

During periods of market volatility, we are all continuously “assaulted” by pontifications and mantras of endless dread.  As these predications are repeated and referenced, they have a tendency to take on a factual air, which only accelerates the negative feedback loop.  Unfortunately, this loop often leads individuals, committees, and even advisors to consider taking corrective action in their portfolios.  Fear is certainly one of the more palatable emotions of the human condition.  However, all too often, reactive portfolio shifts based on short-term volatility are costly and lead to less than optimal outcomes.  Additionally, institutional investors often enjoy a significant advantage over their individual investor counterparts…time.  Speaking of repeating predication, we often remind clients of the following sage advice:

The market is the most efficient mechanism anywhere in the world for transferring wealth from impatient people to patient people. – Warren Buffet

We are not suggesting investors simply ignore all market volatility; on the contrary, we simply recommend a more methodical approach.  Questions should always be asked but strategic action is only warranted after review.  It is important for investors to use market volatility as an opportunity to review their long-term portfolio objectives.  If a market move does not alter a portfolio’s long-term objectives or risk tolerance, the best advice is to use the volatility to reaffirm and rebalance (if the market shift is large enough) the portfolio toward its long-term asset allocation targets.

While often not as quick or as loud as the media assault, the second, but arguably more dangerous, condition often resulting from periods of market volatility is the “magic bullet.”  We define a magic bullet as a new (or old) investment strategy rolled out by the industry which addresses the current market crisis but appears to have no downside.  We have reviewed hundreds of investment products over the years, but we have yet to come across an investment strategy that suspends the laws of risk and reward.  This reminds me of another piece of protective, sage advice: 

The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. – John Kenneth Galbraith

Once again, we are not suggesting all financial innovation is bad.  Some of the most profitable investment opportunities in investor portfolios often come out of financial market dislocations.  However, much like taking a methodical approach to portfolio changes based on market volatility, we feel new investment opportunities should be reviewed objectively and even with a cynical eye.  The primary focus of any strategy assessment should be its investment risk and what could potentially go wrong.  This objective approach to investment evaluation will lead to better decisions rather than simply inserting an investment strategy into a portfolio to counteract fear over current market conditions.

Like a light switch…

Photo credit: Martin Cathrae via Visual Hunt / CC BY-SA