I moved to California with my family nearly 10 years ago. I
have never regretted it. But early last Sunday morning, my family
and I, along with others living in the Bay Area, were reminded of
the downside of life in the Golden State.
Fortunately, last week's earthquake took a greater toll on
property than people. But in addition to providing a stark
reminder of the costs (beyond sky-high housing prices) of living
in San Francisco, it also was a violent, but good, metaphor for
the dangers lurking in financial markets.
Stocks and other risky assets have been doing
particularly well the last few years. So well, in fact, that it's
easy to forget there are risks below the surface. While I
continue to believe that equities and other risky assets
can advance further this year
, it's worth considering what to do when the next shock hits
financial markets. Here are three investing lessons I took away
from last week's earthquake.
1. Shocks, by definition, are unpredictable; their
performance isn't telegraphed to anyone ahead of time.
An earthquake is a very visceral reminder of that. In the
financial sphere, while it's true that a few smart (and lucky)
investors got ahead of the last financial crisis, most missed the
signs and few predicted the magnitude. And market shocks that are
more exogenous in nature (think 9/11) are impossible to predict.
Even today, while investors focus on
the fragility of the Middle East
or the conflict in Ukraine the next geopolitical shock could just
as easily come from North Korea. When the next real shock, which
I'll define as something lasting more than a week, hits, the odds
are few will see it coming.
2. Have your market downturn plan down on
In California, you're supposed to keep an earthquake kit ready.
Ideally, the kit includes food, water, a flashlight and other
essentials. Our own earthquake kit is normally missing the first
item: food. This isn't a reflection of my wife's preparedness;
rather, it's a function of my own bad tendency to raid the kit
whenever I can't find something I want in the kitchen. Going
forward, I'll have to break this bad habit.
For investors, the relevant preparation is to
have a financial plan
, ideally one consistent with your own objectives and risk
tolerance. For example, when the next downturn hits, will you
sell equities to limit losses or use it as a buying opportunity?
The answer depends on your own financial objectives, stage of
life and risk tolerance. But regardless of the details of the
plan, you should have one ahead of time, and it ideally should be
3. Build your portfolio for bad times as well as
Portfolios, like houses, need to withstand the occasional shock.
In the case of a house, this means retrofitting, earthquake
insurance and bolting down the wine rack (as a bourbon drinker,
my earthquake-related bottle losses were thankfully limited).
Recently, some investors have been ignoring this lesson. No
matter how attractive or cheap stocks are, few investors should
be 100% in equities, with the possible exception of the very
young and very brave. But the longer the bull market goes on, the
more tempted many investors are to abandon other asset classes
and seek the higher returns of stocks. The problem is this
behavior can leave you maximally exposed to markets at exactly
the wrong time.
Investors need to build a portfolio consistent with their
objectives, and for most, that means a portfolio that can offer
downside protection as well as upside potential. This means
it's important to have some long-term strategic allocation to
- Treasuries, cash and gold - that tend to appreciate, or at the
very least hold their value, when everything else is collapsing.
While these assets may be a drag on returns today, they serve a
purpose over the long term.
One final, non-financial point.
Movies featuring an earthquake invariably have a scene with an
animal getting agitated before the quake begins. In retrospect,
this seems to be a bit of Hollywood fiction. Every single person
I know said the same thing: their dog slept through the entire
quake. In our case, the only reaction by our golden retriever was
to look visibly annoyed when my wife turned on the lights. It
seems we interrupted his sleep.
Russ Koesterich, CFA, is the Chief Investment Strategist
for BlackRock and iShares Chief Global Investment Strategist.
He is a regular contributor to
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