Prudent investing is risk-averse. You have all heard me say that at least a thousand times. Coming into this election, the market had been on a big run since bottoming in March. Valuations were getting a bit high and we now have political uncertainty.
We said there was a good chance that we would not know who the next President would be on election night. That was not exactly a brave prediction, but as expected, this is indeed the case. We did not know how people would react, and given the summer of incredibly violent “peaceful protests,” we hoped for the best and planned for the worst.
Thankfully the post-election time has thus far been peaceful (knock on wood). The market has surged after dropping dramatically last week. We took protective measures heading into the election and as a result, lost less than the market last week and have gained less this week. We still lost value last week and have still had big gains this week, we have just moved less than the market in both directions. That is risk control.
Risk is a funny thing. Many people will look at the fact that the market has rallied and that everything has thus far been peaceful as proof that these events were certain. That is not true; there was a probability that things could have been much different. Understanding the different probabilities is what investment risk control is all about.
One of the biggest differences between the lay investor and the professional is that lay investors tend to think in all-or-nothing terms. Should I be invested? Should I buy XYZ stock? To lay investors, these are yes-and-no questions. Professionals think in terms of degrees: How invested should I be? How much of this stock should I own? What percentage of my portfolio should it be? These are the questions professionals ask, and they are seldom yes-or-no answers.
Had the lay investor gone to all cash in advance of the election he would have been happy last week and crying this week. The professional doesn’t go to all cash; she trims back her exposure to ride out the possible storms, but almost never shuts down. The problem with that all-or-nothing attitude is knowing when to reverse course. That becomes the guessing game of trying to time the market.
Prudent investors do not try to time the market; they make decisions from the bottom-up. They think in terms of absolute returns, not worrying about missing out on some magic, and that allows them to be risk-averse. Risk control is what allows investors to keep moving forward towards their goals.
We still don’t know who the President will be for the next four years. However, we do know that the checks and balances of our system are still in place. The sun came up on Wednesday, the earth is still spinning, and that is all good news for Wall Street. We avoided the storm, but were prepared if we hadn’t. We will prepare the same way for the next potential storm, and the next. Risk control: that is really the job. As they say in football, “defense wins championships.”
Chuck Osborne, CFA