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The Inevitability of Risk

The Inevitability of Risk

How do you contend with it? How do you avoid letting it unnerve you?

 

Provided by MidAmerica Financial Resources

    

If you want significant reward, you will have to assume some risk. Anyone investing in securities – particularly stocks and funds – must accept that reality.

  

Investing in the markets gives you an opportunity to accelerate the growth of your savings and outpace inflation, and you definitely want that chance – but how do you cope with the risks linked to it?

 

Here are the four varieties of investing risk – and tactics that may help you manage or counteract them.

 

Diversification & concentration risk. This occurs when a portfolio isn’t varied enough. Some investors have everything in a handful of stocks or a couple of funds representing just one or two “hot” market sectors. If macroeconomic factors hurt those companies or industries, that undiversified portfolio may suffer a major setback. Even a bad earnings season may do significant damage.

 

Tactic: Diversify across asset classes, moving money into funds that provide broader market exposure. Avoid a glut of holdings in a given sector – even a sector everyone insists is “hot.” The flavor of the month can sour next month. Broad diversification gives investors a chance to capture gains in different market climates, and sets them up for less pain if a particular sector or asset class dives.

 

Reinvestment & timing risk. All investors would like to buy low and sell high, but some succumb to impatience and leap in and out of the market. In attempting to time the market, they end up hurting the long-range performance of their portfolios. The weakness of buying high and selling low has caused too many investors to miss the best market days. Besides that, bond investors commonly face reinvestment risk – the hazard that a bond’s coupon will end up reinvested someday in a lower-yielding security.

 

With regard to stocks, here are some long-term statistics worth noting. Standard & Poor’s research shows that if a hypothetical investor had simply parked $10,000 in an index fund mimicking the S&P 500 on January 1, 1994 and just watched it for 20 years, he or she would have wound up with $58,350 at the end of 2013. If the same investor was out of the market for just five of the top-performing days during those 20 years, he or she would have amassed only $38,723. Investment research firm DALBAR estimates that from 1991-2010, the average mutual fund investor earned 3.8% a year compared to an average 9.1% annual return for the S&P – and that 5.3% difference no doubt relates to buying high and selling low.1,2

 

Tactic: Instead of jockeying in and out of stocks and funds, buy and hold while scheduling consistent income through bond laddering. Use dollar cost averaging to pick up more shares of quality companies in down markets, with anticipation that they will be worth more in better times. Employ tax loss harvesting: harvest losses to offset capital gains, with the objective of bettering the after-tax return of your taxable investments.

 

Credit quality, interest rate & inflation risk. As you invest in the bond market, these three risks must be watched. A corporate bond’s rating (credit quality) may be downgraded by S&P or Moody’s, for example, implying a greater default risk for the bond issuer and signaling less certainly that you'll redeem all coupons and principal. Interest rates can climb, sending bond prices south. Rising inflation can turn a bond that seemed like a “can’t lose” investment years ago into a loser at the date of maturity.3

 

Tactic: Use individual bond issues in a laddered strategy and/or target maturity bond funds; think about zero-coupon or revenue muni bonds, or explore hybrids like preferred securities or structured notes.

 

General market risk. Anyone with a foot in the markets must recognize systemic risk – the potential that many or all market sectors may be riled by shocks such as a geopolitical crisis, an act of terrorism, a recession or a natural disaster. How do you cope with that?

 

Tactic: If you hold stocks that have logged significant gains, consider adopting a collar strategy for them – that is, writing a call option and purchasing a put option on equivalent shares. This move essentially gives you a covered call and a protective put and targets two exit prices for the underlying stock. Collars can be highly useful when volatility strikes Wall Street, and they may let you hedge positions in certain funds when conditions turn bearish. In the bigger picture, you could look into a core-and-satellite approach to investing: passively managed investments at the core of a portfolio, actively managed investments as the “satellites” seeking greater returns in different market climates under the guidance of a skilled money manager.

    

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

     

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

      

Citations.

1 - fc.standardandpoors.com/sites/client/wfs2/wfs/article.vm?topic=6064&siteContent=8339 [5/5/14]

2 - cbsnews.com/8301-505123_162-57402744/why-investors-are-their-own-worst-enemy/ [3/26/12]

3 - news.morningstar.com/classroom2/course.asp?docId=3035&page=4&CN=com [5/8/14]

 


Rising Interest Rates

Rising Interest Rates

How might they affect investments, housing & retirees?

 

Provided by MidAmerica Financial Resources

    

How will Wall Street fare if interest rates climb back to historic norms? Rising interest rates could certainly impact investments, the real estate market and the overall economy – but their influence might not be as negative as some perceive.  

 

Why are rates rising? You can cite three factors. The Federal Reserve is gradually reducing its monthly asset purchases. As that has happened, inflation expectations have grown, and perception can often become reality on Main Street and Wall Street. In addition, the economy has gained momentum, and interest rates tend to rise in better times.

 

The federal funds rate has been in the 0.0%-0.25% range since December 2008. Historically, it has averaged about 4%. It was at 4.25% when the recession hit in late 2007. Short-term fluctuations have also been the norm for the key interest rate. It was at 1.00% in June 2003 compared to 6.5% in May 2000. In December 1991, it was at 4.00% – but just 17 months earlier, it had been at 8.00%. Rates will rise, fall and rise again; what may happen as they rise?1,2

 

The effect on investments. Last September, an investment strategist named Rob Brown wrote an article for Financial Advisor Magazine noting how well stocks have performed as rates rise. Brown studied the 30 economic expansions that have occurred in the United States since 1865 (excepting our current one). He pinpointed a 10-month window within each expansion that saw the greatest gains in interest rates (referencing then-current yields on the 10-year Treasury). The median return on the S&P 500 for all of these 10-month windows was 7.93% and the index returned positive in 80% of these 10-month periods. Looking at such 10-month windows since 1919, the S&P’s median return was even better at 11.50% – and the index gained in 81% of said intervals.3

 

Lastly, Brown looked at the S&P 500’s return in the 12-month periods ending on October 31, 1994 and May 31, 2004. In the first 12-month stretch, the interest rate on the 10-year note rose 2.38% to 7.81% while the S&P gained only 3.87%. Across the 12 months ending on May 31, 2004, however, the index rose 18.33% even as the 10-year Treasury yield rose 1.29% to 4.66%.3   

 

The effect on the housing market. Do costlier mortgages discourage home sales? Recent data backs up that presumption. Existing home sales were up 1.3% for April, but that was the first monthly gain recorded by the National Association of Realtors for 2014. Year-over-year, the decline was 6.8%. On the other hand, when the economy improves the labor market typically improves as well, and more hiring means less unemployment. Unemployment is an impediment to home sales; lessen it, and more homes might move even as mortgages grow more expensive.4

 

When the economy is well, home prices have every reason to appreciate even if interest rates go up. NAR says the median sale price of an existing home rose 5.2% in the past year – not the double-digit appreciation seen in 2013, but not bad. Cash buyers don’t care about interest rates, and according to RealtyTrac, 43% of buyers in Q1 bought without mortgages.4,5

 

Rates might not climb as fast as some think. Federal Reserve Bank of New York President William Dudley – whose voting in Fed policy meetings tends to correspond with that of Janet Yellen – thinks that the federal funds rate will stay below its historic average for some time. Why? In a May 20 speech, he noted three reasons. One, baby boomers are retiring, which implies less potential for economic growth across the next decade. Two, banks are asked to keep higher capital ratios these days, and that implies lower bank profits and less lending as more money is being held in reserves. Three, he believes households and businesses are still traumatized by the memory of the Great Recession. Many are reluctant to invest and spend, especially with college loan debt so endemic and the housing sector possibly cooling off.6

    

Emerging markets in particular may have been soothed by recent comments from Dudley and other Fed officials. They have seen less volatility this spring than in previous months, and the MSCI Emerging Markets index has outperformed the S&P 500 so far this year.2

   

MidAmerica Financial Resources may be reached at 618.548.4777 or greg.malan@natplan.com.

www.mid-america.us

    

This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

    

Citations.

1 - newyorkfed.org/markets/statistics/dlyrates/fedrate.html [5/22/14]

2 - reuters.com/article/2014/05/21/saft-on-wealth-idUSL1N0NZ1GM20140521 [5/21/14]

3 - fa-mag.com/news/what-happens-to-stocks-when-interest-rates-rise-15468.html [9/17/13]

4 - marketwatch.com/story/existing-home-sales-fastest-in-four-months-2014-05-22 [5/22/14]

5 - marketwatch.com/story/43-of-2014-home-buyers-paid-all-cash-2014-05-08 [5/8/14]  

6 - money.cnn.com/2014/05/20/investing/fed-low-interest-rates-dudley/index.html [5/20/14]





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