Risk isn’t your enemy

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Corrections, which can see markets drop as much as 20 per cent, happen every two-to-three years.

Even people with no investing experience know markets don’t keep rising forever. At some point, values will fall.

Tom Trainor, managing director of Hanover Private Client Corporation, says investors should expect the market to shed value somewhat regularly.

He says pullbacks, where the market declines by less than ten per cent, generally occur once a year. Corrections, which see a fall of ten-to-20 per cent, happen approximately every two-to-three years. Bear markets, a drop of 20 per cent or more, take place every five years or so.

“These things are completely expected,” Trainor says.

But newer investors don’t know to expect those events; and even many who’ve experienced stock volatility have short memories and panic when stock prices slip.

That can lead to panic selling, which destroys the value of investment portfolios. Learning to both expect and accept some market volatility is the first step in beating the temptation to sell low.

In fact, the volatility baked into the stock market is where most of its value comes from. This heightened risk is why returns on stocks are higher than those associated with bonds and other fixed-income products.

“If you knew definitively you were going to get seven per cent or eight per cent every single year [from stocks], then nobody would invest in bonds. Everyone would invest in equities,” Trainor says. “It’s that risk premium that you’re trying to capture.”

If you and your financial planner have determined your portfolio needs to generate seven-to-ten per cent each year for you to maintain your lifestyle, you’re not going to get that from bonds or other assets that don’t keep up with inflation.

Those levels of return require you to maintain a strong equity position and resist the temptation to sell during rough patches.

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When do you need to invest in stocks?

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How much stock market risk you take needs to be based both on financial goals and your time horizon for when you'll need the money.

Figuring out how much risk you’re comfortable with is a complex calculation. And it’s not a purely psychological decision.

Trainor says investors need to have both a financial goal and know their time horizon for needing an income from their investments.

“If it’s more than five, or hopefully more than ten years, just invest in equities,” he says. “If you need the money back in two-to-three years, you probably just want to invest it in short-term bonds.”

Once the income targets have been worked out, it’s time to factor in your risk tolerance.

Maybe your advisor says your goals require a portfolio that’s heavy on stocks, but you’re the kind of person who won’t drink milk the day before it expires. If you’re that risk averse, don’t buy individual stocks because there’s too much chance you’ll start selling them as soon as prices start falling.

In this scenario, you and your advisor want to create a portfolio that leans more heavily on fixed-income assets; one that might only consist of 20 per cent equities.

If that fits your post-retirement income needs, your exposure to the stock market should be manageable enough that the question of holding or selling doesn’t need to be asked.

Diversify and breathe easier

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Index investing can be easier than picking stocks. Either way, though, your equity risk needs to be diversified by industry segment and country.

A well-balanced portfolio is a reliable hedge against market volatility, the experts say.

Trainor says the equity component of a diversified portfolio might include 15-to-20 different individual stocks that represent a mix of countries and industries. But, he adds, investing in major stock indices is a more modern and reliable way to invest.

Investing in ways that track the long-term performance of the TSX or Nasdaq indices is relatively safe. Trying to pick winners and losers with individual stocks, not so much.

So is jumping in and jumping out of individual stocks at just the right time to turn a profit and avoid losses.

“The research has shown continuously that nobody can effectively time the market with any degree of certainty,” he says. “You don’t get paid for single-stock risk.”

Instead, experts say your portfolio should be structured so that a market dip won’t require you to sell off your equities. And it should be multifaceted enough that the returns from its non-equity component (bonds or other fixed-income investments) can compensate for an extended period of sunken stock values.

“We don’t want to be forced to sell stocks in your portfolio during that period of time,” Trainor says. “Make sure your portfolio is properly structured so that you have the cash when you need it.”

Fine art as an investment

Stocks can be volatile, cryptos make big swings to either side, and even gold is not immune to the market’s ups and downs.

That’s why if you are looking for the ultimate hedge, it could be worthwhile to check out a real, but overlooked asset: fine art.

Contemporary artwork has outperformed the S&P 500 by a commanding 174% over the past 25 years, according to the Citi Global Art Market chart.

And it’s becoming a popular way to diversify because it’s a real physical asset with little correlation to the stock market.

On a scale of -1 to +1, with 0 representing no link at all, Citi found the correlation between contemporary art and the S&P 500 was just 0.12 during the past 25 years.

Earlier this year, Bank of America investment chief Michael Harnett singled out artwork as a sharp way to outperform over the next decade — due largely to the asset’s track record as an inflation hedge.

Investing in art by the likes of Banksy and Andy Warhol used to be an option only for the ultrarich. But with a new investing platform, you can invest in iconic artworks just like Jeff Bezos and Bill Gates do.

About the Author

Clayton Jarvis

Clayton Jarvis

Reporter

Clayton Jarvis is a mortgage reporter at MoneyWise. Prior to joining the MoneyWise team, Clay wrote for and edited a variety of real estate publications, including Canadian Real Estate Wealth, Real Estate Professional, Mortgage Broker News, Canadian Mortgage Professional, and Mortgage Professional America.

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