I am going to make this short and sweet…this is a time to practice something I call “aggressive capital preservation.”
I spent this week in Chicago at the annual Morningstar Investment Conference, and it confirmed all of things I have been writing to you about for the past few years. Specifically, that the stock market
has taken returns that really should have been enjoyed in future years, and pulled them forward. This has created a situation in which 15% annualized returns have become normalized, despite the fact that this is nearly double the long-term average of the S&P 500.At the same time, bonds have been little help. Treasuries yield more than in the past, but they are still not nearly at a level that will fund most retirement plans. This has caused investors and financial advisors to try all kinds of financial experiments to slay the yield dragon. Sometimes it is preferred stocks and high-yield bonds with jacked up return potential, but tons of credit risk. In other cases, the risks have already been realized, as in the case of the so-called “Yield Enhancement Strategy (YES).” Peddled by some of the biggest brokerage firms, YES promised higher yield via a complex option strategy. But they ended up losing about 20%, and that has prompted legal action. Many investors simply wish they had said NO to YES.
These are really red flags, warning shots if you will.
The chart above shows how much the S&P 500 and the Nasdaq Composite fell during the past two major market declines, as well as the lesser pullbacks like the pair we had last year. These are lifestyle-changing drops.My concern after a few days of discussions with my industry peers is that the investing public is still suffering from excessive complacency about the vulnerability of stocks AND bonds going forward. I don’t know when or how we will go from that era of complacency to one of investor panic and obsession with capital preservation, but I do know we will get there.And that is why I am using the term “aggressive capital preservation” going forward. To me, this signifies a careful consideration of one’s ultimate objectives as an investor, with lifestyle, family and legacy considerations as the priorities. This means that “what the market is doing lately” is not something that drives investment decisions. The desired outcome of the investment process is the key. That has been my own “obsession” for over 30 years.Related: The Current Stock Market Environment Reminds Me of a Hurricane
How is aggressive capital preservation different from just “going to cash” or massively hedging one’s portfolio against imminent declines in market prices (that may or may not occur)? The key difference is that aggressive capital preservation is not a tactic or a timing measure to guard accumulated wealth from the indiscriminate actions of market speculators, hedge funds, algorithms and the like. It is an investment policy decision, one that makes the avoidance of major losses a permanent priority. That may produce some periods in which the investor will wish they were competing better with the S&P 500 and Nasdaq, but it will also keep them from having to deal with the financial heartbreak depicted in the chart above.Every investor must look at themselves in the mirror at times like these. Risk is high now because returns have been abnormally high in recent years. That means that going beyond the basics like “I will buy bonds to balance my stocks” as 60/40 portfolios do will likely be insufficient to keep many investors within the acceptable range of returns they set for themselves. This is a big part of the risk-tolerance testing I do with clients. And recent market volatility is a stark reminder that such testing is not a one-time deal, but rather something that must be audited on a regular basis. Otherwise, the financial planning process becomes a transaction, not the long-term, flexible plan it was intended to be.Capital preservation is a nice way to talk, but it takes some dedicated planning and concerted, consistent action
to make it happen. Between tariff talk, recession concerns, a stretched stock market, serially low bond returns and rising risk of “reaching for yield,” there has never been a better time to take account of what preservation really means to you, and to aggressively pursue the balance of long-term return and keeping what you have earned that is the biggest ongoing facet of any investment plan.To read more, click HERE