... actually goes up and down.
If I had a dime for every time that I’ve heard this saying about capital markets I’d be one of the richest guys I know. Since the economic meltdown we had ten years ago, U.S. equity markets have done one thing: Appreciate. Not only has appreciation been generating record levels, this level of appreciation has occurred with significantly less volatility than usual.
Those who live in the “what goes up must come down” world may understand physics, but I’m not sure that they truly understand economics. It is reasonable and prudent to assume that all capital markets will appreciate and depreciate to lower values at any time.
But I hear many who talk in terms of waiting for the next market decline as if the decline is permanent and irreparable. Of course permanent loss can happen to concentrated positions.
A concentrated position isn’t some fancy name for a specific type of investment. It simply means that your investment dollars are concentrated in one holding or sector. Just ask holders of shares in companies that no longer exist how painful concentration risk can be when it turns against you.
The term concentration can also apply to an asset class. For example, a landlord who invests in nothing but real estate would have an investment concentration in real estate. Similarly, an investor who owns very large positions in a closely held business or even a multinational conglomerate is also concentrated.
Historically, broad market declines have not been permanent. I’d be negligent if I didn’t chirp that past performance is no guarantee of future results, but historically the markets do frequently rise as time goes on. Think 1929 crash, Y2K, banking crisis and so on. During these, investors were devastated by losses in their portfolio and many were so scared that they moved to the sidelines forever. Of course, looking back, these investors realize the long term opportunity cost of their decision.
The past year has also surprised many investors. Many are preaching the ‘must come down’ story again. While they’ve been wrong for the past 14 months – there will be a time when they are correct. Things will go down again.
With that reality now front of mind, the question is how will you tolerate the next drawdown? If you’ve been on the sidelines, maybe that next market decline is your chance to finally buy at a level you feel is fair.
If you are invested, understand the inherent volatility in your holdings, and assess just how volatile your portfolio may get. With this information, you may now be in a position to reallocate to a less risky or more aggressive portfolio or to unconcentrate your holdings.
With markets, only two issues frequently repeat themselves. Markets will rise, and markets will decline. Understand just how much of each you can tolerate and what you need to do to get your portfolio in a zone that works for you.