Both can be thrilling, but both are also perilous unless you know the risks
On the second-to-last Friday in October, Keystone Resort in Colorado opened for the 2021 ski season with 40 acres of terrain and 2 miles of trails. On the very same day, the S&P 500 and the Dow Jones Industrial Average both hit new record highs.
Of course the two events are not at all related, but investors would be well-served remembering that chasing a peak stock market is a lot like skiing a risky slope. The journey is thrilling, but perilous.
Know Your Risk Level
Market highs often tempt investors to chase momentum, which sets them up for a dangerous fall. A less hazardous run is wisest for the long pull: Staying put and sticking to your risk level at all times.
If you venture out to Keystone or any of the other 31 ski resorts in Colorado, you need to be careful because you can easily find yourself in the middle of some very intimidating ski terrain littered with steep grades and cliffs, exposed rock, narrow cat tracks and very high ski lifts.
Make sure you read the maps because when taking a lift to the peak of a hill, you just might find yourself seeing very little in any direction except the edge of the narrow ridge you are standing on and other mountains off in the distance. There might be – quite literally – nowhere to go but down, and fast.
For some, this produces a desire to retreat. The safest way down from the top of the mountain is to hop back on the aerial tram and ride it to the bottom. You are technically safe, but you miss the point of being there in the first place.
For others, the adrenaline rush is addicting. The opportunity to test their skill, courage and, yes, luck offers a heady excitement. Each time they make it down safely, they begin to forget about all the rocks and cliffs they passed on the way up. Their past success breeds confidence.
Navigating Stock Market Peaks
As U.S. markets continue to reach all-time highs, many investors feel like they are standing at the peak of one of Colorado’s 32 ski resorts. Like the skier who laughs off the risks, investors who stretch too far expose themselves to potentially devastating results.
Let’s look at two investors who go through the same market rise and subsequent market decline.
- Investor Green has a diversified portfolio that earns 10% during the rise, then loses 10% when it drops.
- Investor Black Diamond has a very concentrated portfolio that earns 50%, then falls 50%.
When the market climbs, Investor Black Diamond is praised as a genius at the ski lodge. Everyone wants his advice, and he can’t talk about his investing prowess enough. Investor Green, meanwhile, is overlooked as being a conservative, vanilla investor.
Consider the Impact of Big Losses
What many investors fail to remember is that big negatives hurt performance far more than the equivalent upside.
Remember, if each portfolio is worth $100, then:
- Investor Black Diamond gains $50 first, or $150 in total. A subsequent 50% market dip then leaves him with $75, or a loss of 25%.
- Investor Green, on the other hand, gains a modest $10 to move to $110. Her subsequent 10% loss leaves her with $99, or a loss of 1%.
When you hear about the mathematics of compound interest, it’s almost universally in a positive context. The more important discussion, however, is the impact of losses.
Remember, it’s simple math:
- A 10% loss requires an 11% return to break even
- A 20% loss requires a 25% gain and
- A 50% loss requires a 100% rebound
Skiing off a cliff just once can erase all the gains you make.
What Kind of Skier Are You?
Everyone wants Investor Black Diamond’s portfolio when markets rise and Investor Green’s portfolio when markets decline. We all know that consistently achieving that result is nearly impossible in the investment world, yet many people can’t help themselves from trying.
Stretching for yield during times of low interest rates, abandoning underperforming asset classes, or making guesses about what lies ahead are sure ways to increase the potential for a large loss. Conversely, investors who seek shelter miss out on future gains.
Stay in your comfort zone and remain committed to the level of risk appropriate for your personal goals. Talk to your financial advisory team – the professional ski instructors of Wall Street – and they can help you navigate the terrain for an enjoyable ride.