Real Risk

by | May 24, 2019 | Market Commentary

While at the 72nd Annual CFA Conference in London, a presenter asked a thought-provoking question. What was the riskiest time in the last 50 years?

Now, I spend a lot time thinking about risk. I thought I knew the answer.

Below are all the negative periods in the stock market over the last 50 years. I call this a drawdown chart[1] and it measures how far stocks have dropped from their highs.

 

Accordingly, the riskiest period had to be one of these options:

  1. 2008-2009. Stocks dropped over 50% and our financial system was on the brink of collapse.
  2. 1999-2000. Stocks dropped nearly 45% as the tech bubble burst.
  3. 1972-1974. The market dropped over 40% as the “no-lose” Nifty Fifty (a group of 50 high quality stocks like Johnson & Johnson) fad came to an end.
  4. When, in one day stocks dropped over 20%. We still call it Black Monday.

If you were invested in the market during any of the big blue areas it absolutely felt like the world was ending. The problem is every one of these guesses is wrong.

The riskiest time in the last 50 years? September 1983. This was when an early warning system detected that a nuclear missile had been fired by the United States and was heading toward the Soviet Union. Fortunately, cooler heads prevailed and nothing came of it. As it turns out, there was a glitch that created a false warning. [2]

Nuclear war is true risk. It’s a wipe out. The value of your investments is meaningless after a confrontation with nuclear weapons. Nothing lives one-day after. Yet, the risk is long-term, constant, and hard to measure. We run this risk every day, yet it’s largely ignored. What is not ignored is how much our investments bounce around each day.

That bouncing around is called volatility. Most of us do just fine if we ignore it.

Volatility only measures noise. In the long-term, it barely matters. For instance, a dutiful saver who put away $100 every month into an S&P 500 index fund starting with her first job in 1969 and did nothing else until her retirement in 2019 would have accumulated $1,876,759. That’s an average compounded annual return of 10.2%, or what the market earned in spite of the volatility. That person might ask, what volatility?

So, when it comes to risk, we need to focus on the long-term. We need to focus on what matters. Time horizon should drive risk metrics, making volatility erroneous. In other words, don’t worry what the trade war talks are doing to the value of your investments. Worry, instead, if you are invested in the right asset mix necessary to achieve your long-term goals

 

.[1] Data Source: DFA Returns Web.

[2] https://en.wikipedia.org/wiki/1983_Soviet_nuclear_false_alarm_incident

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