Productive worrying

Judging by recent newspaper headlines, there is plenty for investors to worry about. Nuclear war on the Korean Peninsula, global warming, political scandal and turmoil, Russian interference in our elections, fake news, violent protests and the list goes on.

In fact, it may seem like we are living in a most precarious time for humanity. Some say, perhaps the most dangerous time? But in our estimation, at least for the developed world, times have rarely appeared better. Lifespans are longer than they have ever been, diseases are being tamed and scientific breakthroughs are improving lives unimaginable a few decades ago.

So what does this have to do with investing you might ask? When dealing with an uncertain future, we believe that “productive worrying” is helpful when evaluating investment markets. But, too much worrying can lead to fear or decision paralysis. We remember that a stock trader was being interviewed by CNBC near the bottom of the 2008/09 financial crisis. He feared the market was heading to zero. Of course this fear had no basis in economic reality, but his fear had become so great that he was forecasting a total market collapse.

The flipside of unrealistic fear is irrational optimism or greed. In this situation investors become so enticed by the potential rewards offered by an investment that a rational balancing of risk and reward is discarded in favor of hopes and dreams.

There is some evidence that a few sectors of the stock market may be getting a bit of a bubbly attitude right about now. The promise of self-driving electric cars and other technological innovations has led some to ignore valuations in favor of hope. Some argue that the top technology companies are holding an oligopolistic position over the economy, i.e., “just buy them, they will keep going up”. These bubbly attitudes are balanced by the fact that the memory of 2008/09 still looms largely in a typical investor’s mind. It is rare for a prospective client to not ask how we fared during the financial crisis.

There is a way to measure how the stock market is viewing levels of uncertainty. It is a statistical measure of volatility, called the VIX, and is referred to as the Volatility Index. In the past, it has had a tendency to spike during periods of market stress and severe declines. Today, the VIX index is extremely low perhaps indicating that complacency reins and the above mentioned risks are not being given their due. Another interpretation is that the market doesn’t believe these fears will occur and upend the economic recovery that has been underway since 2008.

What to do about our “productive worrying”. There are some general ways to combat fear and greed when constructing investment portfolios. Here are three avenues we apply:

1 Systematic Approach. This is usually referred to as dollar cost average or periodic rebalancing. The former technique simply invests a specific sum of investment dollars to a portfolio whether the market is up or down. Statistically this has proven to be a beneficial approach for the long-term investor. The latter approach directs investment dollars to the asset class that has underperformed its long-term target in a multi-asset portfolio. This eliminates the emotions of fear and greed from the investment process.

2 Asset Diversification Approach. The hallmark of any investment strategy is the development of appropriate asset allocation targets. These depend on risk tolerance, age, the need to access these funds, and time horizon. Having assets that “zig when others zag” can help maintain a long-term perspective and help minimize the influence of emotion when markets are in turmoil.

3 “Fat Pitch” Approach. Coined by Warren Buffett, “fat pitches” provide an extraordinary reward for a determined level of risk. These don’t occur often but can be observed when the market is in an irrational mode of fear or greed. Of course, in this environment, emotion will be working hard against the investor to take advantage of the opportunity.

Successful investing is often the result of not over-reacting to extreme political and economic news or events. Productive worrying is a useful way to describe how investors can stay abreast of risks and opportunities in the market while not being driven by extreme fear or optimism. Jim Rhodes is a Chartered Financial Analyst and Executive Director at American Money Management (AMM). His offices are at 300 S. Imperial #12, El Centro and can be contacted at 760604-6310. Mike Moore is Chief Investment Officer of AMM and can be reached by calling (888) 999-1395.