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Investment Risk in Bear Country

To celebrate my brother’s high school graduation, we traveled to Yosemite National Park with two other relatives for several days of wilderness hiking and camping – no phones, and only what we could carry in our packs. I will avoid any attempts at artfully describing the park; John Muir coined it “nature’s cathedral” and in two words does better than I could ever hope. It is a place you feel connected – I was lucky to have that sense of belonging on my trip, both with the natural world and the group I journeyed alongside. The hike reminded me of a few risks we all face as investors.

Stupid Risks

The airplane landed late at night, four hours from the park. We had secured lodgings in advance at a popular ‘motel’ about ½ way to our destination. It was a real bargain, and I was patting myself on the back for a job well done. What could go wrong?

I grew up in a small town in central Michigan, but thanks to some life experience, namely a gig selling foreclosed homes in Detroit’s toughest neighborhoods during the 2008 recession, I always note my surroundings and look for potential problems. We arrived at our motel weary from travel and barely able to keep our eyes open. At 2 AM on a Tuesday, the red flags were everywhere. We noticed large groups playing loud music outside their vehicles. At least two or three people roamed the sidewalks, liquor bottles in hand. Outside the motel entrance, a woman in a dress was discretely dropped off by a man in his truck; another entered a passing vehicle. After reaching our room, the neighbors had the frequent noise & commotion, rapid comings and goings, that made it hard to conclude anything other than drug activity. What were we doing, here, of all places?

We settled in, determined to ignore the noise and catch some sleep before the next day’s hike. I couldn’t rest knowing what was going on right outside our door. While the risks to our safety were remote, they kept me anxious for daybreak. For the added cost of a few cheeseburgers, we could have enjoyed much cleaner and safer accommodations. Sure, our budget motel ‘leaves the light on for you’ - but that doesn’t help if you are too scared to turn it off. Things ended just fine of course; the next morning we laughed about the experience over breakfast and looked forward to the coming adventure.

Stupid risks are just plain stupid. The financial planning lesson here is pay up for comfort and security when appropriate. It is okay to think about cost, but not exclusively – if you cut too many corners you may find yourself boxed in. For investments, avoiding stupid risk is probably one of the most important things we can do. Be okay passing on a little upside if it keeps you protected from the big losses. The balanced investment approach is never celebrated but it should be. We all hear about overnight millionaires and high-flying stocks. This leads many financially secure investors to chase returns they don’t need and risk losing it all in the process. Information is moving exponentially faster, and our brains are wired to act now when we perceive a missed opportunity. It is hard to step back and think in terms of years, decades, even generations. But this is the quiet path walked by most successful investors.

Measured Risks

After admiring the sequoia trees of Mariposa Grove on our entry to the park, we hopped on a bus heading north of Yosemite Valley, to a more remote location where we would begin our hike into the wilderness. Laying in my tent that first night, I kept running through an internal checklist. Do we have enough food? Water filters? What will we do if someone gets lost or injured out on the trail? Will these food canisters really keep the bears away? Enjoying the wilderness requires acceptance of a few measured risks. By preparing in advance and following the plan, we enjoyed our hike with confidence. Nature is a wild place – challenging you both physically and mentally, in so many ways. But along with very real challenges it can provide gifts that are beyond words. Pushing past your own limits or fears. Views of mountain peaks, glacial lakes, or cascading waterfalls. And if you’re lucky, recognition, even if only for a minute, that you’re connected to the world around you and part of something special.

Life, investing, wilderness hiking – all of these require acceptance of a few measured risks. There is only so much room in your pack and so many dollars in your investment portfolio. Both can take you incredible places, but you need to accept a reasonable level of measured risk. There is always the chance we run into a bear or some other danger, perhaps one we never expected. This is where portfolio design becomes so important. This is the reason we encourage a balanced and global investment approach – using equity and fixed income - to help you enjoy life’s riches while staying prepared for an unknown future.  

Necessary Risks

The trip to Yosemite was a special chapter in my life, and I hope to enjoy more wilderness hiking in the future. As I started thinking this article to fruition on the flight home, I recognized that we often think too much about the outlier risks and too little about the more frequent and severe risks we face every day. The biggest danger during my trip? Probably the four-hour car ride from San Francisco, traveling through winding roads. Some risks, even scary ones, are necessary to make good things happen. But we get numb to them with routine exposure. We worry about airplanes and bear attacks, but automobile travel is the more prevalent risk, and one we accept daily without much thought. What is the parallel for investors?

This year will change us, and our economy, forever. The pandemic has been a time of explosive uncertainty, and stocks declined by over 30% after Covid-19. Stocks never like uncertainty. In 2008 to 2009 the drop was north of 50%. At my age I can only imagine the fear it invokes to look at your retirement portfolio and watch the dollars decline by these amounts - even if we know these drops are usually temporary and there is a good chance we earn back losses during a future recovery. Stock market risk gets the headlines, and the ups and downs are never easy.  

Our team is viewing the recent equity rally cautiously, noting it involves both higher valuations and optimistic expectations of future economic conditions. But we are also thinking a lot about fixed income at a time when governments are printing money at unprecedented volumes and interest rates are at historic lows. Actively managed ‘core’ bond funds, generally viewed as more conservative along the risk spectrum, now yield just two or three percent per year. The ‘risk free’ interest rate on short-term U.S. treasuries is below one percent. Some foreign nations now have negative interest rates. This means foreign investors loan a dollar to their banks or their government, for a future promise of 99 cents!  

The ‘4% rule’ we cite often for retirees is based on studies supporting good retirement success rates using a 4% annual account withdrawal from a balanced portfolio of 60% stocks and 40% bonds. The studies use historical averages. Over the past 50 years, they show that stocks returned about 10% per year and investment grade bonds returned just over 7% per year. [1] Vanguard forecasts the following average annual returns over the next decade [2]:

  • U.S. stocks = 4% to 6%
  • International stocks = 7% to 9%
  • Fixed income (bonds) = 0% to 2%

Future stock returns are muted, but bond returns are even more surprising. Most people worry about stock performance, but if the world of low interest rates is here to stay, we need to be thoughtful about our bond allocations.

Risk is here to stay, and there is no way to avoid it entirely. We believe retirees may have to accept more equity risk and/or use a differentiated fixed income portfolio to achieve good outcomes going forward. It is always important to think about risk through the proper lens, recognizing that every choice is viewed against the alternatives. We may not love the idea of lower stock returns over the next ten years, but with interest rates as low as they are, the ‘premium’ or extra return we can earn from stocks starts looking attractive! This could be one of many reasons stocks are doing well this year, despite high unemployment and economic shutdowns.

We believe in the power of having a plan and making good decisions. We build portfolios using different asset classes and seeks to balance potential returns with an acceptable level of risk. This means excluding stupid risk, strategically accepting measured risk, and objectively approaching necessary risk. Our long-term and stable investment strategies seek to serve you and your family regardless of current market conditions – hopefully helping you to focus on what matters most: enjoying life and time with your loved ones.

[1] https://www.schwab.com/resource-center/insights/content/why-market-returns-may-be-lower-in-the-future

[2] https://www.marketwatch.com/story/vanguard-comes-to-defense-of-the-6040-portfolio-as-it-forecasts-stock-market-returns-for-the-next-decade-2020-07-23

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any opinions are those of the author, and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.

Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities. Be sure to contact a qualified professional regarding your particular situation before making any investment or withdrawal decision.