Investors who no longer fear their bets could explode are seeking out risks they don’t have to take
By Jason Zweig – The Wall Street Journal.
Bull markets give, and they take away.
One of the most valuable assets erased by this bull market is the distinction between risk taking and risk seeking.
You can’t invest at all without taking any risk. Even if you keep 100% of your money in Treasury bills backed by the U.S. government or bank accounts insured by Uncle Sam, that isn’t risk-free. You run the very real risk that, at today’s paltry interest rates, the income you earn won’t maintain its purchasing power. Net of inflation, you are highly likely to lose money.
That’s an involuntary risk, one that no investor in those assets can avoid. A long bull market, however, goads many investors into taking voluntary risks. They seek bets they don’t have to make.
Consider Robert Gilmour, 69 years old, who lives in the Dallas-Fort Worth area.
He’s been trading full-time since late January. At one point, he says, he was using about $200,000 in margin, or borrowed money, and held as many as 160 stocks, sector funds and exchange-traded funds, a number he calls “ridiculous.” Mr. Gilmour has scaled back—no longer trading heavily on margin, he’s down to 96 holdings—but he can’t seem to stop.
On Aug. 30, Mr. Gilmour spotted Zoom Video Communications Inc.’s stock falling sharply in after-hours trading. “I said to myself, ‘I’ll just load up and make a killing tomorrow when it goes back up,’” he recalls. The next day, it went down 17% instead. “And I took my usual bath and swore never to do it again,” says Mr. Gilmour, “until I saw Wells Fargo was down that night, so I bought it, and I paid the price the next day” [when it fell another 5%].
A retired accountant, Mr. Gilmour logs all his trades—several per day—in a spreadsheet. He’s made about $18,000 in profits since he began trading full-time. “If I’d just parked the money in some index funds I’d probably be up a lot more than I am,” he says with a rueful laugh.
“It’s not such a good way to invest, maybe,” says Mr. Gilmour. “But it has kind of become my life.”
That isn’t so surprising: The S&P 500 has closed at new all-time highs 54 times so far this year, making it seem almost as if the market will never go down again. And people often take more risk when the environment around them feels less risky.
You probably feel safer riding your bicycle fast if you’re wearing a helmet. You’d be more inclined to take curves on a mountain road at high speed in a sturdy SUV than you would in a compact car.
In much the same way, the low-interest-rate policy of the Federal Reserve and other central banks around the world has made the market environment less risky—thereby prodding investors into behavior that’s more risky.
In years past, you could typically earn about 5% on your cash without any risk other than losing your purchasing power to inflation. So you had to gain at least 5% to justify taking a risk in the first place. Seeking risks wasn’t safe; avoiding them was.
The epic recovery from the Covid crash of early 2020 has made it all but impossible for most of us to reconstruct how afraid we were only a year-and-a-half ago.
All that changed in the financial crisis of 2008-09, when the Fed slashed interest rates. Along with other central banks, the Fed has kept rates near zero almost continuously since then. Now, keeping your money safe carries a cost.
Loose monetary policy isn’t the only force pushing people into seeking risk.
Try recalling how frightened you felt as an investor in February and March 2020.
You can’t do it, can you?
The Covid-19 pandemic was raging, the economy had shut down, millions of people had lost their jobs and the S&P 500 fell 34% in less than five weeks.
No matter what you think now, you were terrified then. Everybody was.
But the epic recovery from the Covid crash of early 2020 has reinforced the sense that markets are safer now. After that 34% collapse, stocks hit new highs again only 126 trading days later.
That’s made it all but impossible for most of us to reconstruct how afraid we were only a year-and-a-half ago. We see the past through a rearview mirror made of rose-colored glass. Brushing aside our losses creates a false bravado that makes us think we can weather the future with less fear than we suffered in the past.
To stay out of trouble, ask yourself whether you are taking risks you don’t need to.
Stocks are up 22% so far in 2021, while bonds have been flat. Even if your target is a conservative 50/50 mix of stocks and bonds, the bull market has probably bumped you to 55% stocks and 45% bonds. Without even taking any action, you’ve taken on extra risk.
To get back to your target, sell some stock, buy some bonds or both.
Also ask: Is this a risk I need to take? Imagine making 10 times your money on an investment. How would your life be different? If your answer is a shrug, then the risk isn’t essential. Now imagine losing everything. Is the trade worth making at all?
Finally, ask whether it’s a risk you understand. Who’s on the other side of this trade, and why are they willing to let you make money? In a severe bear market, you’re often trading with someone who has to get out or go broke so you may have the advantage. In a bull market, it’s often someone who knows more than you do.
You have to take risks. You don’t have to seek them, especially when ever-rising prices make the market riskier than it feels.
Featured article licensed from the Wall Street Journal.