When building an investment portfolio, a true investment risk assessment is a crucial step. How you watch the market and react to volatility is also important.
Here is why you should rethink your “market crashing” theory.
One of the most frequent questions we hear at PAX Financial Group when the market has a little dip is, “Is this the big one all over again?” The “big one” is a reference to the 2008 crash. We all have scars from that year. But don’t be fooled; when fear creeps into your brain, be consciously prepared. When you become concerned, you will then find yourself accepting, ever so subtly, the same scary whisper from every corner of your life. This frequent repetition becomes familiar and makes it hard to distinguish from the truth.
The truth is that market dips are normal and expected. But they do feel a little different today. It may help you in your investment strategy to understand that the market is like a child with a Yoyo on an escalator.
The Yoyo is volatility. The Yoyo is all the ups and downs, and all the downs and ups. Today, the Yoyo is the combination of the following four new market norms:
1. High-Frequency Trading: High Frequency Trading (HFT) refers to computer trading, which happens at a rapid pace and attempts to make money through the compounding of small wins. The companies behind this strategy will go as far as to pay a premium for high bandwidth to get an edge.
2. Retail Traders: The age of Scottrade and Schwab is a positive. But the indirect consequence is a massive increase in visibility and access. When retail investors see volatility, they tend to react with emotion.
3. Algorithm Trading: Algorithm trading is based on computer models used by financial advisors and other institutions. They give a green light to buy and a red light to sell. When all the red lights go off at the same time, everyone sells.
4. Exchange Traded Funds: Exchange Traded Funds (ETFs) are like mutual funds but they can be sold in the middle of the day (whereas mutual funds can only be sold at market close). If the noise of the media gets too loud, everyone reacts in unison and sells their ETFs right after lunch, causing more market volatility.
You could place some blame of recent stock market volatility on the above four new market norms. But, I wouldn’t worry about them too much. Those four are the “Yoyos.” Instead, focus on the escalator.
The escalator is the long-term reality that companies will continue to sell soap, gum, boots, coffee, toilet paper, tobacco, tires, music, books, computers and a record amount of Star Wars movie tickets. Why will they continue to sell products? Because we keep buying them. And not only do we keep buying them, but the new middle class also keeps buying them.
Take a look at the increase in the global demand for stuff. Every year, a new middle class appears ready to buy an iPhone, and this middle class is equal to the entire population of Canada! The escalator screams that products will still be consumed and companies will still make money – the escalator will continue to go up.
To answer the original question, “Will the market crash?” I really doubt it. The probabilities of a crash are not as high as the alternative. We need to start betting on optimism. Frankly, I’ve never met a successful pessimist.
Again, volatility is a normal part of the market cycle. We expect it. We just don’t know how long a volatile market will last at any given time. That’s why it’s important to work with a financial advisor you trust; an advisor who understands your true risk and how much risk you can comfortably take based on your personal situation. That’s where an investment risk assessment comes in.
Tolerance for risk is different for everyone, and knowing what you can afford is one of the most important elements in your investment decision; you need to be able to commit to your plan regardless of what the market is doing.
Remember, your risk preference and your risk capacity are different.
- Risk tolerance: The amount of risk an investor WANTS to take.
- Risk capacity: The amount of risk an investor actually CAN take, both emotionally and psychologically.
- Risk preference: The amount of risk an investor NEEDS to take to reach his or her financial goals.
Understanding these terms, how they apply to you personally and how the market performs over time are all important factors when starting an investment strategy.
Make sure to talk with a financial professional who can help. Making the wrong decision and working with the wrong advisor (or no advisor) could cost you a lot in the long run. At PAX Financial Group, we take a holistic approach to investments, taking our client's entire situation into consideration when setting a plan to help them reach their specific goals. Contact us to see how we can help.
This material is provided by PAX Financial Group, LLC. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The information herein has been derived from sources believed to be accurate. Please note: Investing involves risk, and past performance is no guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested. 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 market indices discussed are unmanaged and are not illustrative of any particular investment. Indices do not incur management fees, costs and expenses, and cannot be invested into directly. All economic and performance data is historical and not indicative of future results.