Investors are sickened by the plunge in value of their portfolios. There is a message in the numbers. Let me tell you why you should listen to it.
I divide investors into three basic groups:
Conservative risk investors: These investors have 60%-85% of their assets in bonds and the balance in stocks.
Moderate risk investors: These investors have 35%-55% of their assets in bonds and the balance in stocks.
Aggressive risk investors: These investors have 0%-30% of their assets in bonds and the balance in stocks.
I am going to assume that the stock and bond portions of all of these portfolios are invested in a globally diversified portfolio of low cost index funds.
Here is a range of returns for each risk type, as of the close of business on October 10.
Conservative investors had losses ranging from 5%-15%.
Moderate investors had losses ranging from 17%-25%.
Aggressive investors had losses ranging from 27%-39%.
What are these numbers telling you?
First: The higher the expected returns, the greater the risk. Investors who seek these returns must have the time horizon (and stomach!) to wait out the bad times in order to achieve the long term superior returns which are the reward for the risk they have taken.
Second: If your losses are greater than the range of losses in your risk category, you need to reevaluate your portfolio. Many investors had no idea of the risk of their portfolios. The chances are very good that the additional risk in your portfolio is "uncompensated", which means that you could obtain the same expected returns with less risk, by holding a more diversified portfolio.
Very few investors know the risk of their portfolio. When I give talks to groups, I ask for a show of hands for those investors who can tell me the risk of their portfolio as measured by standard deviation. Less than 1% respond.
I tell every investor to go back to their broker or advisor and find out their standard deviation. Most report back to me that the broker has no idea what they are talking about, much less how to compute it.
Bill Bernstein, the author of The Intelligent Asset Allocator, wrote: "If your broker is not familiar with the concept of standard deviation of returns, get a new one."
To which I would add: If you have uncompensated risk in your portfolio and don't know your risk, why are you using a broker?
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.
The Morning Email helps you start your workday with everything you need to know: breaking news, entertainment and a dash of fun. Learn more