On Friday, August 21st, 2015, the Dow Jones Industrial Average finished the day down 10.1% from its May record. Last Friday was the fourth consecutive day of declines in the Dow, losing over 500 points to finish at 16459.75.
This crossed the 10% threshold that typically defines a correction. A market correction is generally defined as a rapid change in market pricing or indices in order to achieve a new equilibrium price. In this case the rapid plunge implies that the market was in a state of over exuberance and finally accounted for the macro events that are increasingly affecting investor exposure to systematic market risk.
1. Market Volatility Is Here to Stay: Consider Patient Capital
It is becoming increasingly clear that market volatility is here to stay. This can be caused by numerous factors including domestic and international economic conditions, global interdependencies and changing levels of public policy and involvement typically utilized to stave off market recessions.
However, volatility is not necessarily a bad thing. Increased market risk can create new pockets of opportunity, but market fear affects rational decision-making by investors. More often than not, the perceived importance of liquidity and fear of portfolio decreases cause myopic thinking, rendering investors unable to take advantage of the opportunities that are created amidst market volatility.
Increased market volatility is a fundamental variable that is here to stay, and investors increasingly need to understand that portfolio investments (unless stated explicitly otherwise) should target a longer term view. Waiting for things to settle down or monetizing on fear-based market drops is not within the core competency of many investors or even within their capabilities. This continuously supports the fact that money management by established professionals with a clear fiduciary duty in mind is for the benefit of most investors.
There are so many current market conditions including financial instability in Greece, changing energy prices, and China’s growth and government intervention. A more patient and forward-looking perspective on portfolio building is needed in lieu of these macro events.
2. Financial Literacy Needs to Increase
Even within the United States the financial literacy of the non-institutional investor is relatively low. Information is consumed as produced by media and other professionals, but there is very little work that goes into an internal understanding and perspective on market and investment conditions throughout the world. This in and of itself is somewhat ironic given that the state of an investor’s portfolio is probably one of the most important elements of a lifetime of work.
This holds true not only for investors, but also for advisors. In order to deliver true value add for their clients, advisors need to increase their acumen with regards to the types of products that are available for achieving their clients’ goals of dampening market volatility and looking at long-term, above-alpha growth.
3. Portfolios Need to Target Long-Term Growth
As a more in-depth component of financial literacy, portfolios need to be built for long-term growth and dampened volatility. Oftentimes stability is confused for growth, but in reality portfolio growth capabilities are mitigated by a decreased-risk return profile. As an example, an entire portfolio that is comprised of fixed income products would indeed prove to be stable, but likely will not produce any portfolio growth.
Many advisors and investors have mistakenly put the idea of liquidity on a pedestal over both portfolio growth and decreasing market correlations within a portfolio. The latter two can be accomplished through the inclusion of alternative investments which have historically proven to have lower market correlations. As global interdependencies have increased correlations across the entire traditional stock and bond spectrum, looking for portfolio-enhancing assets that are outside of the box will become increasingly critical in portfolio growth as well as client retention from the perspectives of financial advisors.
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