When I was just a young man, I would go with my dad to visit his mom (my grandmother). She was a very frugal, former school administrator, who lived in a duplex near our home.
For whatever reason, the duplex did not have air conditioning and instead she would open all the windows and doors and run an old box fans during the summer months. I can remember getting bored with the adult conversation and I would sit in front of the fan to feel the cool breeze and hear the calming hum of the fan.
Like many a kid, I would eventually move to the backside of the fan and marvel at how the beating of the fan blades distorted the sounds of my voice.
“Hello, hello, hello,” I would say.
I would marvel at the way that the fan distorted my voice into a deeper, drawn out version of the original hello.
The fan helped to circulate the air from one window and out another using cross ventilation. However, I can also remember hearing thunder clouds and lightning while there and my grandmother and father would quickly work to close many windows, some 100% and some less, but they heeded the warnings.
Sometimes, we would be too slow to close the windows and doors or the storm would sneak up on us. When this happened, we would feverishly work as a team to close all the windows and doors to keep that rain from coming in the house.
This process was a form of risk management. If we closed the window and doors, even if not entirely, we hoped to manage the possible risk of loss from water damage if the rain was able to blow into her duplex.
Risk Management Today
Similar to the risk management my grandmother displayed before a summer rainstorm, we as prudent money managers also must perform risk management. Like the approaching Indiana summer storm, we are really never sure how violent the storm will be, nor whether it will produce significant damage to the portfolio or not. However, much like closing doors and windows, it is better safe than sorry, even though a majority of storms produce very little in the way of damage.
One of the things we do well as a firm is practice this risk management. Our average portfolio since 2003 has captured less upside over the years, just 88% of the benchmark’s upward movement.
However, the big news is the same average portfolio has only captured 72% of the benchmark’s decline in percentage terms.
We believe there is a time to open the windows and doors and turn the fans on high. In money management this is a new bull market or market move after an extended correction.
There is also a time to partially shut the windows and doors, so that a light rain does not damage the portfolio. This is where we move portfolios when we deem caution is warranted.
Finally, there is a time to shut all the windows and doors and if you are in Florida, to board them up, because the storm is going to be a big one and has the potential to create a lot of damage. This is when that caution turns into a major bear market, like we had in 2007-2008.
History Says, Risk Management Pays
Unfortunately, in the highly competitive, managed market we now find ourselves, too many managers have forgotten the risk management element or portfolio management. They will say “it doesn’t pay to manage risk, or the Fed has our backs.”
You know what? They may be right in 9 out of 10 occurrences. However, it’s number 10 that defies the odds and creates long-term damage. After the longest bull market in history, you have to ask yourself, is this one the one out of ten. You know the occurrence that is different from the rest.
We thought we had that in March of 2020, but quick intervention by the Federal Reserve and by Congress saved the day. Will they be able to save the day next time now that we are at even higher highs and have blown an even bigger bubble?
As a student of history, all we need do is go back to the market declines of the 1920s and 30s to see what can happen after a market bubble. An investor that was fortunate enough to get out before those crashes, may have lost a little of their returns, but was quickly back to breakeven and then profits in the years that followed.
The investor who rode down those markets spent the next 25 years wishing they had practiced better risk management! Only in 1954 did they finally get back to breakeven. Tell me that would not have fatally altered your retirement planning?
I am not saying we are headed for a new depression, although it is possible. What I am saying is it only takes one “big one” to ruin everything you have saved a lifetime to grow.
Think of it liking buying insurance. Sure, there is a cost to insurance, especially if you never need it. However, it provides peace of mind and even more if you ever need those funds. All it takes is one!
So maybe my “hello, hello, hello” in the fan as a youth was really closer to the “hello McFly” from the movie Back to the Future? A wake-up call to those who continue to cheat fate and practice no or limited risk management, while the world blows bigger and bigger financial bubbles!
Let us know if we can help! We are happy to offer a free second opinion on your portfolio.