The im­por­tance of risk man­age­ment

Annapolis Valley Register - - OP-ED - David dea­con Dol­lars & Sense david dea­con is a port­fo­lio man­ager with sco­tia Wealth Man­age­ment in Kentville. His bi-weekly dol­lars and sense col­umn ap­pears in the an­napo­lis val­ley reg­is­ter. He can be reached at david.dea­con@sco­ti­

In­vest­ing suc­cess­fully re­quires pa­tience and dis­ci­pline more than any­thing else, es­pe­cially late in a mar­ket cy­cle, as we ap­pear to be in now.

The temp­ta­tion to buy near the peaks is over­whelm­ing and is the down­fall of many well-in­ten­tioned in­vestors, when, in fact, sell­ing may be the wiser de­ci­sion. How can one buy low if they don’t first sell high? I have learned over my six cy­cles as a money man­ager that my job in­volves not just the man­age­ment of port­fo­lios but the man­age­ment of risk. We must avoid the de­ple­tion of cap­i­tal due to mar­ket cor­rec­tions by re­bal­anc­ing port­fo­lios to­ward fixed in­come (bonds) when stock valuations get stretched to the up­side, as they are now.

With this in mind, I will high­light six time-tested risk man­age­ment rules im­ple­mented by some of the most suc­cess­ful money man­agers of our time:

1. War­ren Buf­fett, Berk­shire Hathaway – “Be greedy when oth­ers are fear­ful and fear­ful when oth­ers are greedy.”

2. Ray Dalio, Bridge­wa­ter As­so­ci­ates – “The big­gest mis­take in­vestors make is to be­lieve that what happened in the re­cent past is likely to per­sist. Typ­i­cally, high past re­turns sim­ply im­ply that an as­set has be­come more ex­pen­sive and is a poorer, not better, in­vest­ment. Ul­ti­mately, what goes up must, and will, come down. Even­tu­ally, great com­pa­nies will trade at an at­trac­tive price. Un­til then, wait.”

3. Seth Klar­man, Bau­post – “In­vestor be­hav­iour is the big­gest risk in in­vest­ing. Greed and fear dom­i­nate the cy­cle, which ul­ti­mately leads to buy­ing high and sell­ing low.”

4. Jeremy Gran­tham, GMO – “You don’t get re­warded for tak­ing risks, you get re­warded for buy­ing cheap as­sets. Suc­cess­ful in­vestors avoid risk at all cost, even if it means un­der­per­form­ing in the short term. The rea­son is that while Wall Street and the me­dia have you fo­cused on chas­ing mar­ket re­turns in the short­term, ul­ti­mately, the ex­cess risk built into your port­fo­lio will lead to poor re­turns in the long-term.”

5. Howard Marks, Oak­tree Cap­i­tal man­age­ment – “Rule No. 1: Most things will prove to be cycli­cal. Rule No. 2: Some of the great­est op­por­tu­ni­ties for gain and loss come when other peo­ple for­get rule No.1. Un­der­stand­ing that all things are cycli­cal sug­gests that, af­ter long price in­creases, in­vest­ments be­come more prone to de­clines than fur­ther ad­vances.”

6. Ja­son Zweig, Wall Street Jour­nal – “Re­gres­sion to the mean is the most pow­er­ful law in fi­nan­cial physics. Pe­ri­ods of above-av­er­age per­for­mance are in­evitably fol­lowed by be­low-av­er­age re­turns, and bad times in­evitably set the stage for sur­pris­ingly good per­for­mance.”

7. Bob Far­rell, Far­rell Cap­i­tal – “Ex­cesses in one di­rec­tion will lead to an op­po­site ex­cess in the other di­rec­tion”.

To­day, the in­vest­ment greed level is el­e­vated, as de­ter­mined by the fact that the amount of bor­rowed money in the U.S. stock mar­ket is at all-time high. That is re­ferred to as a “risk-on” mar­ket. Of course, lever­age works both ways and can be the fuel which ig­nites a sell­off. I be­lieve that ad­her­ing to the rules and guide­lines of risk man­age­ment men­tioned above is as im­por­tant to­day as at most any point in his­tory. like us on face­book face­ kingscountynews

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