“Risk is good. Not properly managing your risk is a dangerous leap.” ~ Evel Knievel
Prologue
Markets continue their strong start to the year as economic data remains resilient. The stronger economic data and sticky inflation has raised concerns that rates will likely remain higher for longer and the market doesn’t seem too concerned…for now. Many market observers have touted the idea that the Fed is likely to achieve a ‘soft landing’.
The definition of a ‘soft landing’ in the business cycle, according to Wikipedia; “is the process of an economy shifting from growth to slow-growth to potentially flat, as it approaches but avoids a recession. It is usually caused by government attempts to slow down inflation.”
What has been interesting this hiking cycle is the relationship between interest rates and economic growth. Based on academic research, many would believe that the transmission mechanism of higher interest rates to slowing growth typically takes six to nine months from the start of the rate hiking cycle. We’re well beyond that now. The Fed has implemented one of the most aggressive hiking cycles in history only to see modest impacts on growth and inflation.
Some of the most dangerous words in investment are “this time it’s different” and while using them as a general catch-all to explain the unusual is fraught with danger, that is not to say that some factors will change from one economic cycle to the next. However, expecting the economy to respond ‘as normal’ to interest rates and the economy is very different to that now. Things never repeat themselves, but they do often rhyme.
All of this does create a conundrum for Central Banks. It could be argued that, for the first time in many years, the goals of financial market stability and price stability (fighting inflation) are at opposite ends of the scales. Financial stability has clearly become a more prominent risk and difficulty for banks will tend to make loans somewhat harder to come by, and therefore will tighten financial conditions – but the magnitude of the recent tightening of conditions can be difficult to quantify.
Of course, what matters most is how conditions evolve moving forward, and it certainly seems reasonable to assume that credit conditions are going to tighten no matter what, perhaps even replace the need for the Fed to hike further to achieve their price stability goals. One would think that investor risk aversion could accomplish the same goal, though the enthusiasm with which speculators have bought tech stocks (see chart of the month below) suggests that animal spirits (and thus the potential inflationary pressure) remain all too alive and well.
Soft landings, as with all landings come with varying degrees of turbulence. Central Bankers in the cockpit may have to deal with course corrections, gusting winds, and more air pockets before the wheels touch down on this landing – please keep your seat belts fastened!
Please reach out with questions.
-Paul
Noteworthy links:
- RJ: Debt ceiling: Common sense prevailed
- RJ: When should you ignore conventional retirement advice?
- Capital Group: Why the next economic recovery may be stronger than expected
Chart of the Month
The market continues to get narrower and narrower
Article of the Month
Identify the connection between net worth and risk tolerance
Understanding your risk profile is an important component of managing significant wealth.
Nobody wants to financially erode the portfolio they’ve built by making risky choices at the wrong time. You spend nearly half of a lifetime working hard to prepare for a secure retirement, so no wonder it isn’t easy to convince yourself to embrace risk. As vital as wealth preservation is, especially when nearing retirement, returns are still an important consideration.
So how do you get over the risk hurdle? Research shows your financial advisor can help. Those who work with an advisor perceive potential higher-risk investments with less negativity. They’re also more apt to recognize the importance of holding thoughtfully selected risk within an investment portfolio compared with wealthy investors who don’t partner with an advisor.
But how risky is too risky when it comes to wealth preservation and generating returns for high-net-worth investors? You might be surprised.
Sometimes looking at the numbers is an exercise in perspective. Investors with significant wealth have a greater ability to absorb financial losses than others - but emotion can sometimes get in the way of seeing the broader context. An amount that may initially cause “sticker shock” may actually be a fraction of your liquidity when considering the bigger picture. Your advisor may be able to run simulations that show how your unique portfolio would react to market pullbacks or changes in interest rates. Seeing these potential outcomes can help clarify the level of risk that fits your tolerance and your investment goals - and it may turn out to be higher than you thought.
Age is less important when determining risk for investors with significant wealth. Your investment time horizon - the length of time you expect to hold an asset - is an important component of risk tolerance. Older investors typically have a shorter time horizon given their proximity to retirement and the usual need to make portfolio withdrawals at that time. However, age may have less impact on the overall risk tolerance of affluent investors whose income needs in retirement are already accounted for. If it’s unlikely you’ll need to liquidate assets in the near term to meet your spending needs, it may be appropriate to maintain a less-conservative allocation for longer.
Being too conservative can be a risk unto itself. Avoiding undue risk is always wise. However, you want to be sure to balance risk with potential return when it comes to your overall plan to outpace inflation and meet your financial goals in retirement, whether that’s supporting your grandkids’ education, giving to charitable causes or taking that once-in-a-lifetime trip. With the more complex planning needs that come with being an affluent investor, it’s important to discuss with your financial advisor an asset allocation that can help maintain your lifestyle over the long term.
Focus less on market timing and more on the timing of your life. Creating a diversified portfolio and revisiting it as your life and goals evolve is more important than any one investment decision. Your financial advisor can help you determine which opportunities provide the best potential for reward for the risk taken that aligns with your unique circumstances, life plans and goals, and provide you with the peace of mind not to 'jump” into and out of the market at the wrong time.
More risk assets, more thoughtful rebalancing. Because private wealth individuals typically hold meaningful wealth in risk assets like equities, which can change significantly in value over time, it’s important to establish a plan with your advisor for periodically returning your portfolio to its target asset allocation. It’s also important for your advisor to see the whole financial picture; holding assets in multiple accounts without informing your advisor of your full portfolio may increase the risk of becoming overly concentrated or underexposed to certain markets. Your selected strategy will have important tax consequences, so talk through various approaches to determine the best fit.
Create a steady withdrawal strategy for retirement. Capital preservation is important to prevent income loss. You’ll still need to ensure your liquidity needs are met with a holistic income strategy. Consider the income sources you’ll have in place, which may include Social Security, pensions, annuities, dividends, bond coupons, etc., and work with your advisor to address any potential mismatch between what’ll be generated and what you’ll need to maintain your desired lifestyle as well as access capital if there is ever a need.
Confront concerns head on. One way to bring comfort to the idea of taking on risk is to simply talk about it openly. Have conversations with your financial advisor to help you understand your risk tolerance today and how risk can affect your future. When ideas and numbers become more tangible, they become more manageable. Your financial advisor can speak directly to the matters that will impact your portfolio the most but change your lifestyle the least.
Maintaining a large portfolio into and through retirement doesn't have to mean giving up on returns and opportunities for growth, when that risk is managed thoughtfully. It just may take a true understanding of your overall financial outlook, and transparent conversations with your financial advisor, to help you get there.
Here is a link to the full article: Identify the connection between net worth and risk tolerance.
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