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How is it possible to lose $14K in 8 months when the Dow is only 200 points when you're supposed to be mitigating risks?

Dec 12, 2015 in  |  Flag
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Peter C. Karp Level 20

Bolaki,

To evaluate performance without bias a few things need to be considered. In brief, to remove bias, we need to keep in mind risk and how indices are constructed. There are two types of risks to consider: systemic risk and non-systemic risk.

Systemic risk This is commonly known as overall market risk. No matter how diversified a portfolio is, it is always susceptible to market risk. The indices generally represent this fairly well and a good example are the recent corrections in August and September.

Non-systemic risk This is the risk when looking at your holdings within your portfolio and often represent the difference between your portfolio’s performance compared to indices. If your portfolio is well diversified, this risk should be close to zero and your portfolio should be more representative of the index it is modeled after. However, if you are over concentrated in individual, risky positions then your performance can either be higher or lower than the indices. At a glance, it seems to me managing your non-systemic risk will help you get more stable returns.

Indices Lastly, I just want to point out that certain indexes are created differently. For example the Dow is comprised the top 30 blue chip stocks and the index is price-weighted. This means that price per share greatly influences the impact on how each of the thirty influences the index. Unless your portfolio contains all stocks and the positions are by majority the blue chip stocks in the Dow, it may not be the most appropriate benchmark for you to compare performance for.

I hope this clears things up for you.

Disclosure: The posted information is for informational purposes only. This message does not constitute an offer to sell or a solicitation of an offer to buy any security. All opinions and estimates constitute Karp Capital's judgment as of the date of the report and are subject to change without notice. Accordingly, no representation or warranty, expressed or otherwise, is made to, and no reliance should be placed on, the fairness, accuracy, completeness or timeliness of the information contained herein. Securities offered through Infinity Securities (a registered broker-dealer, member FINRA, SIPC). Infinity Securities and Karp Capital Management are not affiliated companies.

Comment   |  Flag   |  Dec 16, 2015 from San Francisco, CA

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Richard P Taylor Level 17

First of all, anything is possible. I think the question should be is it reasonable that a portfolio could drop that much. The answer is: it depends. If you have a very large portfolio in the millions of dollars, I would say that is very reasonable and should be expected. If your portfolio is say $100K or less and it drops that much, it is less acceptable. With the little information that you provided, I would say you were not expecting that type of volatility, thus you are probably not allocated properly. It's always good to have a good long conversation with your advisor about your risk tolerances and risk capacity. For instance, aggressive clients should expect volatility in their portfolio. Conservative clients do not expect it, however, they accept lower returns over a long period of time. Everybody is different and your situation is unique to you.

Comment   |  Flag   |  Dec 14, 2015

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Most investors typically overestimate the level of risk they are willing to accept and underestimate the level of risk in the market. This is why investors need to periodically update their risk profiles not just once at the opening of an account.

If you have invested in a broadly diversified mutual fund, you have been getting some level of risk mitigation through diversification. On the other hand, if you're invested in a sector fund or in funds that are focused on specific high growth/high risk parts of the overall market - like Emerging Markets or Energy Stocks or Hi Yield Bonds - you're going to have outsized drawdowns when those areas are out of favor as they are now.

Perhaps you're using a tactical management approach for your investments - not likely available within a 401k but an option for money outside it. Some of those approaches work and sometimes they don't.

Without knowing the overall portfolio, your personal risk tolerance, your time frame and the specifics of any tactical approach you or your investment adviser are using, your question is unanswerable.

Comment   |  Flag   |  Dec 14, 2015 from Amesbury, MA

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Also remember it's not a "loss" unless you sell, though that doesn't negate the validity of your question

Comment   |  Flag   |  Dec 14, 2015 from Manhattan, NY

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I agree with Richard and Nick, consider the size of your portfolio. What percent is a $14k loss to your overall investment? If the DOW is down 200 points, that's about a -1.1% drop, are you close to that number? I would also look at your allocation and sector exposure. Energy and commodities have been performing very poorly as of late, are you over-allocated to these areas? Perhaps it is a good time to perform a risk review.

Comment   |  Flag   |  Dec 14, 2015 from Salt Lake City, UT

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The tough part for investors is to realize that just because an index is doing something, doesn't mean YOUR holdings are doing the same thing. I don't know the amount of loss you are speaking about, in percentage terms, but while the indices are down a few percent for the year, there are many industries/sectors that are down over 15% and many stocks down well over 50%. So, I would reevaluate how you're managing your investments or how your broker is. It sounds like it isn't properly allocated or being managed. Please feel free to reach out to me if you have any specific questions or want to talk further. -Nick

Comment   |  Flag   |  Dec 14, 2015 from King of Prussia, PA

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Also remember it's not a "loss" unless you sell, though that doesn't negate the validity of your question

Comment   |  Flag   |  Dec 14, 2015 from Manhattan, NY

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It has been said by others before me, but perhaps you'd appreciate reading it again. First, a decrease of $14,000 could be a lot for a small portfolio, or it could be in line with the daily volatility for a larger account. Second, your allocation, most certainly is not going to act just like an index. If you had exactly the same 30 stocks as the DJIA, in the same percentages, you'd end up very close, except any strategy has expenses, which an index does not. If your allocation has international holdings, you'd expect your portfolio would have done somewhat worse in the recent markets, but that is not likely to always be the case. In some time periods, international investments would have outperformed the DJIA, or almost any domestic index. Likewise, smaller stocks have faired poorly compared to larger stocks recently, but the long-term returns of smaller stocks are actually better than larger companies.

If your strategy is based on good diversification (thousands of stocks via a few mutual funds that cover different asset classes) and expenses are kept to a reasonable cost, and your particular level of risk is properly established, then you will see periods of time where you underperform, just as you will see periods of time where your strategy seems to excel in comparison to the index. Of course, if that was the case, you'd be patting your advisor on the back, if you even noticed. Most people only notice the negative periods.

Comment   |  Flag   |  Dec 14, 2015 from El Paso, TX

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I agree with the above answers and would add that it sounds like you are more "LOSS" averse, than "RISK" averse. This tells me right off the top that you are currently taking more risk than you're willing to accept.

Comment   |  Flag   |  Dec 14, 2015 from Orlando, FL

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Brian Kuhn CFP® Level 17

Thanks for submitting your question. I or any financial planner would need to look at your statement to tell for sure. But what percent of your total account does the $14,000 represent? Is your account allocated to asset classes that are different than large cap US stocks like the DOW? Even if you do own mostly or all large cap US stocks like the DOW represents the fund managers you have could be invested in companies that have lost more value than the DOW over the last 8 months. If you reply with your holdings and value I would be happy to reply further.

Comment   |  Flag   |  Dec 17, 2015 from Fulton, MD

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