I’m hearing that a fair number of people are worried about another stock market sell-off coming imminently. The second wave of Covid-19 is underway, many equity markets are back to being near their pre-Covid-19 levels, and the US election is causing fear of significant political and social change. And these are just the risks we are aware of. Unknown surprises provide the biggest shocks to markets, and 2020 has had no shortage.
Effects of Quick Risk
The risk most investors feel viscerally is quick risk. Quick risk results from a swift equity market crash reducing wealth materially, an especially dangerous scenario for a retiree. Until now, there has been a simple and effective solution to this quick or fast risk-reducing equity weighting and increasing bond weighting by investing in a well-diversified balanced portfolio matching your income requirements and capacity for risk. Problem solved? Maybe not anymore.
With interest rates low and safer government bonds paying very little income, the future expected return on bonds is minimal. The safety margin of owning them has also been reduced. The form of risk that needs just as much attention from investors as fast risk is slow risk.
Effects of Slow Risk
Like a turtle placed into a pot with room temperature water, slowly raising the temperature without the turtle noticing and the turtle starts to boil, this is the type of slow risk investors now face with the traditional bond allocation side of a balanced portfolio and other “safe” investments. Slowly over time, the GIC’s, Interest savings, investment-grade government bonds are at real risk of losing purchasing power to inflation. Each $100 not keeping up with inflation could have its purchasing power eroded by 20% over 10 years.
“Successful investing requires that investors navigate around a large number of risks throughout their lifecycle. We believe that the two most daunting risks investors face are the risk of failing fast and the risk of failing slow.” – Corey Hoffstein, Newfound Research.
Managing Quick and Slow Risk
Investors are now faced with tough choices to combat slow risk: save more, spend less, reduce return expectations, take more equity risk, seek alternate investments, and/or some combination of all of the above. Understanding these risks allows for building a well-constructed portfolio to withstand the broad range of outcomes the future may hold.
Marc