Steering Clear of Losses
Financial losses come in many shapes and forms and our clients rightly spend a considerable amount of time worrying about them but managing loss aversion poorly can make the long- term outcome even worse. It is important to pick the right battles, to trade off cost of protection with loss severity and to not lose sight of the ultimate investment goals.
How people perceive financial losses and how they would behave pre-emptively in the expectation (or fear) of potential drops in their portfolio value is highly personal, as it depends on a combination of experience, emotions and personality. However, we, in our aim to act as rational investment professionals, focus on understanding three things: how a potential risk affects the long-term performance versus the objective, what can be done to reduce the chances of this happening and how its cost compares to the long-term benefits.
The impact of losses must be measured across two dimensions: space and time. The deeper the loss or the longer its duration, the more the portfolio will have to recover from a drawdown to achieve its investment goal over the investment horizon. It's intuitive, but here is where the first irrational behaviour appears: people tend to be more afraid of an overnight 30% crash than one of similar depth but spread over, for instance, 2 years. The former is more extreme and highly unusual, but the latter is more detrimental to long-term returns as it not only erodes capital, but time too.
Long-term destruction of capital can be mitigated, or even avoided, by effective asset allocation and diversification. Asset classes such as defensive equities, high yield bonds or emerging market debt can help mitigate equity risk without significantly affecting the overall portfolio expected return, while government bonds, cash, gold or liquid alternatives can offer even lower correlation to risk assets, with the main drawback being lower long-run expected returns.
At expatwealthatwork, we spend a lot of time considering downside risk scenarios and always strive to provide our clients with a more stable journey toward their goals. Our multi-asset, multi- strategy portfolios offer ample breadth along with genuine diversification and are strategically built to offer the best expected long-term outcome given a certain risk profile. On an ongoing basis, though, we also assess market conditions and shorter-term dynamics and tilt our portfolios accordingly, always mindful of costs and potential outcomes.
Contrary to what most bankers or advisors practice, portfolio management is not simply about picking a few funds and stocks that we think might perform well next week or next month, or coming up with a couple of trading ideas for tomorrow based upon the latest media noise. Portfolio management is about identifying those investments that are likely to provide an attractive return for your capital and which, when combined together in a portfolio, provide a superior return than the sum of the individual component returns. The science behind portfolio management is important, but it can be more than a little dreary to even financial professionals. What is important to you is the principles that underlie how your banker or advisor applies that science.
We will never chase (or promise) returns in excess of what we believe that markets can deliver, because we know that the positioning required to do so increases the risk profile of your portfolio exponentially. We believe that you should have exposure to a range of investment opportunities and a portfolio should not be excessively concentrated in a particular position or sector, no matter how confident in a position one is. The investment universe is vast and concentration risk is the cancer that destroys far too many portfolios.
Now is the time for a Free Portfolio Review! Find out if you are on track to meet your financial goals. We will provide you with a free, no-obligation portfolio review to help you understand:
1. If you are taking too much risk.
2. If you are paying too much in fees.
3. If you own investments that are unsuitable or inappropriate for you based on your individual or family situation.
Please contact us - thank you.