Is the market scary or dangerous?
Scary things can hurt us, but aren’t very common—like shark attacks or terrorism or radiation causing cancer. We read news stories about them and get worried. Dangerous things are things we tend to ignore but do long-term damage more often that you think—like avoiding an annual physical, or working on our budgets, or changing the oil. We underestimate these risks because dealing with them takes work on our part.
In finance, there are lots of scary things: Brexit, recessions, the US election, Fed policy. Any one of these—or several of them at once—can cause a market correction of 5 to 10%, or even a bear market of 25 to 50%. We’ve lived through a couple of bear markets over the past 15 years—and a bear market in bonds 20 years ago. They’re frightening.
But if our finances are structured properly, these storms should leave us relatively unscathed. Unless you have to sell your equities during a downturn, the losses that market volatility brings are temporary. And you can avoid selling during a bear market by having a enough of your liquid assets in cash or short-term bonds that have relatively stable prices.
But financially dangerous things bring permanent losses—like not having an estate plan, or not setting money aside in an IRA or 401(k), or being underinsured. These are things we can control, but we don’t like to think about them. They’re not glamorous. No one’s going to make a movie starring Brad Pitt and Angelina Jolie about the irresistible attraction of a balanced budget.
There are scary and dangerous things in the markets: like using your emotions as a guide, or leveraging a concentrated portfolio. If you bought $10,000 of Berkshire Hathaway 30 years ago you’d have $70,000 today. But if you bought $20,000—borrowing half the shares on margin—your shares would have been called away when Berkshire shares fell by 50% in the late ‘90s.
Berkshire Hathaway Shares. Source: Bloomberg
Scary and dangerous things can both hurt us, but one poses a more significant threat than the other. Volatile markets are scary. But they only become dangerous when they encourage us to turn our fears into reality.
Douglas R. Tengdin, CFA
Chief Investment Officer