May 2, 2018
Michael B. Binnicker, CFP®
Relationship Manager, Balentine
“No hot tips,” Balentine & Company proclaimed tongue-in-cheek in an ad for Atlanta Steeplechase in the mid-1990s. A lot has happened in those 20+ years—markets have fallen precipitously and roared back thrice over—but the mantra still holds true. What have we learned since then, and, more importantly, how can we apply those lessons going forward?
Volatility—for better and worse—is a naturally occurring byproduct of the capital markets.
The first quarter of 2018 reminded us of this, first in February due to inflation grumblings, and again in March because of interest rate issues, among other things. While certainly uncomfortable, the volatility of the first quarter is not unprecedented; indeed, it is typically the rule, not the exception. Since 1980, the S&P 500’s mean intra-year decline has been 13.7%. Despite the drops over this time frame (including the crash of ’87, the tech bubble, and the Financial Crisis of ’08), the market delivered positive returns in 29 of those 38 years, or 76% of the time. The annualized rate of return over those 38 years is 8.9% even with volatility rearing its ugly head.
Can’t we just ignore the volatility?
This is easier said than done. Research by economists Danny Kahneman and Amos Tversky shows that the pain of losing money is at least two times stronger than the satisfaction of an equivalent gain! Simply put, people hate losing money more than they love making money. Diversified portfolios exist for this very reason. By developing a thoughtful plan that helps you meet your financial goals (while allowing you to sleep soundly at night), we can mitigate the risk that you, as an emotional investor, pose to your portfolio.
Risk plays an integral part of our holistic approach to both investments and wealth management. Typical formulas to calculate risk simply think about time frames until retirement; in reality, it’s much more complex. Millennials’ aversion to the stock market is a much-discussed example of this very idea. With this in mind, Balentine has developed a framework to help our clients understand how we, as a firm, think about risk:
- Risk Capacity: the ability to take risk
- Risk Tolerance: the willingness to take that risk
Investors fall across the risk spectrum for countless reasons, but talking with your financial advisor about your risk tolerance allows us to determine an appropriate investment strategy. Additionally, understanding the risk spectrum helps guide the framework to changing your mindset about how the portfolio is going to behave and perform over time.
Is risk really a four-letter word?
Global stocks markets grew every month from October 2016 to December 2017; however, this is the exception, not the norm! While short-term memory can influence investors’ expectations, we know that the stock market does not grow in a straight line. In fact, while over the last 20 years the market has grown at an annualized rate of 7.2% through the end of 2017, in only one of those 20 years did it come within +/- 2% of that number. The way we think about our portfolios growing at the same percentage every year must evolve. Changing the paradigm to understand this pattern of growth is paramount to long-term investment success.
Balentine’s portfolios are constructed to achieve investment success over a full market cycle (typically seven years) across a spectrum of goals defined by a set of metrics: expected return, volatility, yield, and max drawdown. Each year, our Investment Strategy Team shares these updated expectations in our Capital Markets Forecast.
As a relationship manager, my singular focus is marrying my client’s definition of risk to his or her investment strategy’s expected drawdown. Why am I so focused on the downside? The path of returns weighs heavily on your mind. After all, as entrepreneur Jim Rohn once said, “We must all suffer from one of two pains: the pain of discipline or the pain of regret. The difference is discipline weighs ounces while regret weighs tons.” We must identify the threshold at which you begin to lose sleep at night and implement a strategy that will not breach it. By acknowledging and accepting a range of outcomes that meet your definition of risk and achieve your financial goals, you are far more likely to stay invested for the long term without capitulating in times of extreme market duress.
Ultimately, slow and steady wins the race.
Today’s bull market was built upon a wall of worry, and the news media have contributed to that with sensational and troublesome headlines. As my colleague, Bradley Martin, recently wrote in the Atlanta Business Chronicle, “At the end of the day, however, news is a business like any other, and news organizations have a product to sell.” Life happens around us all the time. While past performance does not guarantee future results, it does shape future probabilities. More than 20 years later, we still don’t have any hot tips to offer. However, we continue to refine our model-driven, quantitative investment process and innovate in the area of financial planning, all with the goal of helping our clients sleep well at night and, ultimately, finish in the money!
 Source: FactSet
 Source: FactSet
 Source: FactSet – SP500 Total Return
 The expected drawdown is the maximum loss we would expect that investment strategy to experience over a 12-month period with a 95% level of confidence.