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Time to check your risk speedometer
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By Fund Library News Wire  | Thursday, September 28, 2017


 



By Bill McNabb, Chairman and CEO, Vanguard Group, Inc.

More than a decade ago, a well-known American investor and commentator published a memo to his clients titled simply “Risk.” In it, he distilled the relationship between investors and risk. “When you boil it all down, it’s the investor’s job to intelligently bear risk for profit,” he wrote. It’s not surprising, then, that everyone from portfolio managers to behavioural economists avidly studies how investors’ reactions to risk influence not only their individual investment decisions but also the broader financial markets.

I’m a big fan of some of the behavioural finance work being done, which includes studies by Vanguard’s own investment strategists and analysts.

A lens on investor behaviour

For example, in January our Investment Strategy Group introduced a “risk speedometers” report to look at how investors are reacting to market developments. This lens on real-world behaviour measures the risk investors are taking in a given period by calculating the difference between net cash flows into higher-risk assets such as equities, and net cash flows into lower-risk assets such as U.S. Treasury securities. The measures are then compared with long-term averages.

In the spring, our risk speedometer spiked. The rise was fueled by investors’ decisions to direct more of their money to equity investments in developed and emerging markets and to riskier bond credit categories.

A spiking speedometer seems a fitting analogy for what can happen when one’s guard is down. I consider myself a responsible driver. Still, when the highway is clear and the weather is nice, I might glance down at the speed gauge and find that my foot has gotten a little heavy.

The same phenomenon is possible with an investment portfolio. Just as our attention can drift from our speed (and our risk level on the road), investors can neglect the risk level of their portfolios’ asset allocations. Experience teaches that investors are especially prone to lose sight of risk when markets have been buoyant.

How I manage risk in my own portfolio

Rebalancing is one of the best ways I know of to help manage risk. Without rebalancing, a portfolio may end up potentially riskier than intended and no longer aligned with the investor’s goals.

I have a ritual I perform every June and again each December, between Christmas and New Year’s, as I prepare for a series of annual meetings with the Vanguard crew. I’ll set aside some time, review my investment portfolio, and, if necessary, rebalance back to my target asset allocation.

My own portfolio is a mix of equity and fixed income funds, and I invest in both actively managed funds and index funds. Most years, I’ll make a minor adjustment to get back to the appropriate asset allocation for my own longer-term goals and risk tolerance. It’s not all that complicated, although my portfolio is a little more complex than some because I own more funds than we’d typically suggest. (As chairman, I feel I should own a significant number of Vanguard’s funds.)

Consider your options

You should consider rebalancing if your target allocation is off by 5 percentage points or more. Admittedly, this is often easier said than done. When an investment has performed exceptionally well, people have a hard time trimming it. They can be led astray by an old (and none-too-helpful) investing maxim: Let your winners run.

Fortunately, in recent years we’ve seen all sorts of investors take steps to rebalance. Many of the endowments, foundations, and traditional pension plans that Vanguard serves have good processes built into their investment guidelines to make sure rebalancing takes place on a regular basis. And among investors enrolled in defined-contribution retirement plans, more and more are using target-date funds, in which rebalancing happens automatically.

If you choose to rebalance on your own, use your target asset allocation as your guidepost. Don’t be afraid to buy into bad news. In a sense, don’t worry about the noise of the marketplace. If you work with an adviser, make sure he or she understands the importance you place on your rebalancing ritual.

And remember, the goal of rebalancing is to manage risk, not to avoid it altogether. Risk is inherent in investing – we just want to bear that risk intelligently.

That insightful memo on risk I mentioned earlier included a saying often attributed to the American humorist Will Rogers: “You’ve got to go out on a limb sometimes because that’s where the fruit is.”

F. William McNabb III is Chairman and Chief Executive Officer of Vanguard Group Inc.

Notes and Disclaimer

© 2017 by Fund Library. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. This article first appeared on the Vanguard Group, Inc.’s website. Used with permission.

Important information

The views expressed in this material are based on the author’s assessment as of the first publication date (September 2017), are subject to change without notice and may not represent the views and/or opinions of Vanguard Investments Canada Inc. The author may not necessarily update or supplement his views and opinions whether as a result of new information, changing circumstances, future events or otherwise.

While this information has been compiled from sources believed to be reliable, Vanguard Investments Canada Inc. does not guarantee the accuracy, completeness, timeliness or reliability of this information or any results from its use.

This material is for informational purposes only. This material is not intended to be relied upon as research, investment, or tax advice and is not an implied or express recommendation, offer or solicitation to buy or sell any security or to adopt any particular investment or portfolio strategy. Any views and opinions expressed do not take into account the particular investment objectives, needs, restrictions and circumstances of a specific investor and, thus, should not be used as the basis of any specific investment recommendation.

All investments, including those that seek to track indexes, are subject to risk, including the possible loss of principal. Diversification does not ensure a profit or protect against a loss in a declining market.

Please consult your financial and/or tax advisor for financial and/or tax information applicable to your specific situation.

This material does not constitute an offer or solicitation and may not be treated as an offer or solicitation in any jurisdiction where such an offer or solicitation is against the law, or to anyone to whom it is unlawful to make such an offer or solicitation, or if the person making the offer or solicitation is not qualified to do so.

In this material, references to “Vanguard” are provided for convenience only and may refer to, where applicable, only The Vanguard Group, Inc., and/or may include its affiliates, including Vanguard Investments Canada Inc.

 
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