Financial Literacy

Creating a ratio by dividing the price of one asset by another is one way to determine if something is relatively cheap or expensive. For example, comparing gold/silver, stock market/oil, real estate/stock market, and numerous other ratios. In general, you are seeking an extreme low ratio to buy one and sell the other (as a pair trade) and when the ratio is extremely high, do the opposite trade. This is called relative value trading, trading one product (a long position) against another product (with a short position).

There is a ratio extreme right now between gold mining companies and gold; which has an average of 1.5 Gold Miners/Gold over the last 70 years. As you can view in the chart, gold miners have not been this cheap compared to the price of gold since the 1950s. Could the ratio go lower? Absolutely, much lower. However, the ratio has been moving sideways since 2016.

This could be a great trade as gold mining stocks usually move up 2-6 times over the price of gold, when there is a big run up in gold price. Be aware that junior gold mining stocks (ticker GDXJ) are more volatile and riskier than larger gold mining stocks (ticker GDX). One gold analyst said that, “If the price of gold make a new all-time high, then I’m going to buy gold mining stocks to get an added boost in return.”

Adhering to your personal values when selecting investments that you want to support or avoid is common. You may choose to skip investing in companies that provide sins, vices, or conflict with your personal values. For example, your list of stocks to avoid may be businesses involved with alcohol, cigarettes, gambling, marijuana, opioids, military defense, and pornography. There are many ways to screen companies; you could select stocks with only U.S. manufacturers or avoid products made or sold in a country run by oppressive governments like Cuba, Venezuela, or North Korea.

Investment funds and advisors seeking to market to investors’ tastes create mutual funds, ETFs, and lists that correspond with these criteria for easier investing. A big problem arises when these investing criteria move beyond the obvious toward popular but fuzzy terms such as rating a business’s sustainability, environmental impact, social justice, diversity, consumer privacy, engagement, green, inclusivity, responsibility, ethics, human rights, faith-based, corporate governance, etc. These terms are so subjective that you must ask the person using them exactly what they mean. And remember, these definitions change over time. The result of this confusion is that companies are being unjustly rewarded and punished with inaccurate labels by investment funds and advisors.

*Note, some of the common vernacular today is “ESG,” an acronym for environment, social, and governance criteria for investing; “SRI” for social responsible impact; “DI” for diversity and inclusion; and “CSR” for corporate social responsibility. While many institutions claim they have ‘vigorous and in-depth methodologies’ for scoring their ESG labels, the briefest glance at them reveals this is not at all true. Try to find the exact details on how they actually evaluate a specific criterion for a company:  

https://www.msci.com/documents/10199/123a2b2b-1395-4aa2-a121-ea14de6d708a

Some of the issues leading to erroneous ratings and investing conclusions from these ill-defined ESG terms occur because you are entering into the endless stormfront of:

• Conflicting study results
• Not evaluating all of the cradle-to-grave elements to a solution
• Promoting several types of unfairness to reduce one type of potential unfairness
• Failure to consider side effects and secondary / tertiary consequences
• Political correctness hypocrisy
• Subjective and biased trade-offs that are assumed, not reviewed
• Junk science and mistaking correlation with causation
• Popular misconceptions, fallacies, and error propagation
• Requiring failed socialist precepts in governing policies
• Wind/solar manufacturing and intermittency is usually solved with fossil-fuel energy
• Poor behavior as one-time events vs. ongoing part of company culture
• Demanding corporate policy changes for manufactured problems that do not exist
• Judgments with incomplete information
• Utilizing plastic vs. its alternatives that have a +400% higher carbon footprint
• Unsettled science with conclusions that have been flip-flopping
• Falsified data, fake allegations, and debunked assertions
• Confusing efficiency with sustainability
• No reporting data or visibility to actual behaviors that matter
• Financial sustainability is sometimes just financially unaffordable welfare
• Political propaganda overriding factual details
• Mandating product improvements that physically do not exist
• Plus numerous other issues (for brevity, I deleted over 20 additional points)

A certification example that highlights just a few of these problems is LEED certification (leadership in energy and environmental design). In the early 1990’s, the National Resource Defense Council developed LEED construction standards for buildings that reduce their environmental impact over regular construction. This became an international standard and popular for businesses to highlight their green commitment. Many governments provide tax credits only for LEED certified buildings. However, there is a long list of criticisms about LEED certified buildings, including energy and water usage being poorer than regular construction. For every architect that thinks LEED is on the cutting edge of progress, there are architects who claim: it requires inappropriate materials, does not respond to changes in technology, increases the cost and energy to build more than any efficiency can recover, suppliers may have bribed their way onto the approved list, that LEED has devolved into a scam to sell fake PR (called greenwash) to grab millions in tax credits. Some call LEED a taxpayer-funded fraud that worsens environmental impact – the opposite of the one item it was supposed to improve. There are similar criticisms for supply-chain certifications such as “Fair trade,” “Conflict Free,” “Biodegradable,” and even “Organic.”

When simply planting trees to “help the environment” is rife with reverse side-effects that overwhelm any benefits, critics of ESG labels claim that it is just the latest snake-oil in “Virtue Signaling” marketing by opportunists to the gullible. In a recent Youtube video, the founder of a large ESG financial advisory firm vilified an industry as being inherently unethical, and included any supplier related the industry. He published this without citations, evidence, or confirmation – just inflammatory remarks from some professional victims. Yet, with a single mouse click, I found contradictory evidence and the logical explanation for one of his “unethical outrages” he used to publicly malign an innocent industry.

ESG has caught the attention of the U.S. Securities and Exchange Commission. It is now investigating whether ESG Investment Funds are making false claims by looking into the criteria and methodology for rating a company for ESG. One SEC commissioner, Ms. Hester Peirce, says, “ESG has no enforceable or common meaning. They are relying upon research that is far from settled… We should be wary of a self-appointed crowd pinning a Scarlet Letter on a business for fun and profit.” This is not surprising because no company gets the same ESG rating by any ESG advisors.

Why are you investing at all? Likely to reach your financial goals – so you want to place money with the highest likelihood for it to become more valuable over time. Bloomberg did a 7-year backtest among the S&P 100 stocks. They compared the highest rated ESG stocks compared to the non-compliant ESG stocks and the result was the non-compliant stocks performed 50% better than the companies deemed “virtuous.” (Of course, there are other studies performed by ESG firms, with a clear conflict of interest, that make the opposite claim). Expressing your personal values in your investments can be important, and as an investor, you will likely come across ESG marketing materials from investment brokers and advisors. In my opinion, you should never allow anyone else to stamp a company for you with vague and possibly incorrect labels.

On December 31, 2019, Iranian military attacked the U.S. embassy in Bagdad. Three days later, a U.S. drone strike killed the planner, General Qassem Soleimani, who the U.S. claims was plotting another imminent attack. While most people are interested in the politics of the events, money managers have a professional duty to react, professional traders are looking for profitable trades, and retail investors many want to protect their portfolio.

What positions did these investors and traders examine and consider?

1. France and Germany moved into Iran right after President Obama’s nuclear weapons development deal in 2015. So shorting French oil companies (or the French stock market) while buying U.S. oil companies is a pair-trade worth considering, and would already be showing profit.
2. The military/defense ETF ticker symbol “ITA” holds several major military and aerospace companies. Many investors bought this ETF (which has gone up 3% in the last two trading days). Or, you could hedge this trade by also shorting the S&P 500 Index, on the expectation that the defense stocks would outperform the overall stock market.
3. Some investors were just concerned with protecting their portfolio, buying February put options on the S&P 500 Index as insurance. Since puts are somewhat expensive, instead, some bought a vertical debit spread to lower their cost and risk for this hedge.
4. Crude oil jumped up from $61/bbl by nearly $3 because Iran is a large oil exporter. Once the price backed off $1, some investors opened a short-term butterfly trade to profit from the spike up in volatility pricing for the crude oil options on futures.
5. Another portfolio protection trade is to purchase gold. Gold has also been up about 1.5% in the last 2 trading days. (To execute this quickly, you can buy ticker symbol “GLD” with one click).
6. Today, the option volatility for oil is higher than gold, which is in turn higher than the stock market. So there is an opportunity for a combination trade of selling oil options and hedging with buying either gold or S&P 500 options.

I’m sure there are many more ways to have traded this news event (did natural gas keep up? or will the Chinese/Indian stock market be hurt – the two largest buyers of Iranian oil? Will Tesla got a boost as a non-gasoline alternative vehicle). Having a plan to protect your portfolio at any moment is something you should always have ready. But depending upon the news of the day, there are opportunities to profit for those willing to evaluate and immediately place trades before the opportunity disappears.

There is a spectrum range from Total Control to No Control over your financial accounts and investments. The term “control” in this context refers to your money-management capability of: timing of purchases and sales, the type of account an investment is placed into, the options of available investments, having liquidity to get out of the investment/account, minimizing government restrictions, physical possession, and decision-making over the operations of the actual investment.

The most helpless position is having little or no control over your accounts or investments. It is best to save, build, acquire, purchase investments and accounts with the most control, given your knowledge and time to manage that investment, account, or business. The most personally disastrous financial problems occur with accounts where you have no or little control. This is because they can be reduced or eliminated without your input. Examples of this nature include your social security retirement or company/government pension. Within the last several weeks, General Electric froze their pension plan for 20,000 employees (they had already eliminated it for new employees back in 2012); France announced retirement pension cuts and there is still rioting; and Netherlands announced their retirement plan is in peril, and needs financial reform to remain solvent.

Let’s review a few normal investments of the average investor, ranking them for personal control:

No/Little Control

• Social Security retirement benefits
• Company pension

Minimal Control

• 401(k), 403(b), 529, Health Savings Accounts that are held a prison of very limited mutual funds
• Annuities

Average Control

• Stocks, bonds, and mutual funds
• Cash value in life insurance products

Moderate Control

• Promissory notes secured by real estate
• Savings accounts and bank certificates of deposit

Maximum Control

• Cash
• Physical gold and silver
• Rental real estate
• Small business where you have significant ownership

It is best to increase your knowledge and skill to acquire and add money to investments and accounts with the most control that you can.

60 years ago, if you owned 10 individual stocks and a few bonds, an investing expert would consider that a “well-diversified” investment portfolio. Several decades later, in the financial collapse of 2008, the Yale Endowment Fund had so many other types of investments that just 6% of the endowment was in stocks. There are several types of investments with a low correlation to stocks that would further diversify your portfolio. A few of them include:

• Direct real estate
• Commodity funds
• Long/short hedged funds
• Private equity
• Funds of funds
• Pre-IPOs
• Arbitrage funds
• High-frequency trading
• Venture Capital
• Mezzanine debt
• Royalty Funds
• Precious metals of silver and gold
• Possibly cryptocurrencies
• Plus many varieties and combinations of all of the above

Purchasing a stock index fund and a bond index fund takes no investing knowledge. However, it is also taking on a tremendous amount of risk today. This is due to a shockingly high price level of the stock market along with record lows in global interest rates set by central bankers.

A prudent investor might seriously consider lightening their U.S. stock market exposure as well as any medium to long-term bond funds. Then, they’d begin educating themselves on investing in some of the other types of investing classes. For the average investor, there are more online platforms to access these types of investments than ever before. This way, you can begin to invest in areas where the greatest and most sophisticated investment teams in the world are placing their money. By moving beyond just stocks and bonds, you’ll be joining the ranks of a modern “diversified investment portfolio.”

A value trap is a stock that appears to be trading at an attractive price, luring in unsuspecting investors. But instead of being cheap, it turns out to be a losing company or investment. The stock price will be trending downward, leading to capital losses for investors who purchased it by thinking it was a good value. This came up recently when a casual investor I know said he was considering buying Philip Morris because its current dividend yield is a very attractive 7.8%. Plus, analysts are projecting this year’s and next year’s earnings to be higher. I explained that, in my opinion, this is exactly what a value trap looks like.

When a stock has been trading within a certain range for metrics such as:

• Stock price
• Price/earnings ratio
• Price/sales ratio
• Book value
• Dividend yield (the Siren song for retirees and beginning investors)
• Etc.

And when the stock price/metric falls below that range, many investors think, “Hey, it’s cheap now, I better jump on this bargain price before it disappears!” What these investors are failing to see is that there may be a material reason, something fundamental to the company that is creating a dim future for the business. It appears cheap only because the company may be at the beginning of a slow downward contraction. These material reasons can include:

• This industry is being replaced, disrupted, or slowly disappearing
• This company is simply unable to grow revenue or find positive investments
• This company is on an unsustainable path of new debt or stock buybacks
• The company has poor accounting or ignores capital asset and restructuring charges
• The company has flat or dropping revenue but earnings are increasing only from cost cutting – a tactic which cannot last forever
• The company makes a large acquisition for its size – and is starting to not go well
• This closed-end fund with a high payout yield is actually returning capital, lowering its net-asset value, and has an unsustainable business model. So it will dilute your equity position, reduce the dividend, or worse – all of which will create capital losses as the price drops.

There are many classic examples of large and successful companies that became value traps to any investor that bought them on their slow path to zero: Eastern Airlines, Eastman Kodak, K-Mart, Blockbuster Video, General Motors, Toys R Us, Compaq Computer, Zenith Electronics, Radio Shack, and many more. In the case of Philip Morris, it has several red flags for being a value trap: revenues are not increasing; smoking is becoming more unacceptable around the world; and their JUUL investment into vaping is rapidly deteriorating as legislatures are banning its sale. The stock is priced high for big growth and if that doesn’t arrive, sooner or later, the stock will be re-priced lower. Perhaps Philip Morris can re-invent itself, as so many successful companies have. But until then, in my opinion, it is a potential investment value trap that I would avoid.

How wary should you be with Wall Street and new business models without sustainability? The shared workspace company, WeWork, was moments away from an initial public offering (IPO) valued at an unbelievably large $50 billion when it all quickly vaporized. Just a few weeks later and the company is worth less than 10% of that, and will certainly go bankrupt before December if it isn’t bailed out by former investors (like their largest investor, Softbank). It was finally revealed that there were staggering operating losses and the founder, Adam Neumann, had a rats-nest of personal siphons to the business (unethical conflicts of interest), plus he contractually obligated the company to IPO through loan covenants. A long line of top investment banks (lead personally by JP Morgan’s CEO, Jamie Dimon) were all set to sting the public and pension funds with this quagmire of certain bankruptcy, while raking in a few billion for themselves.

WeWork sought to build a business around shared office rentals from freelancers, business incubators, co-working and home-worker office arrangements. Instead of owning the buildings, WeWork was gambling with long-term leases while their own customers had very short-term leases. This is a business 101 mistake of mismatching the timing of your liabilities and assets. In addition, WeWork was competing with the building’s owners, who have far lower costs. This is partly why WeWork was losing so much money in a spectacular economy. Business writer Dan Alpert wrote, “WeWork’s entire business model seems to be a prank. Their business is taking on unhedged risk that no one sober would make.”

After filing for their IPO on August 14^th, investors finally got a look at their financials, hidden among the New Age hyperbole, and discovered:

• For each of the last 3 years, their losses nearly equaled their revenue (For example, in 2018 they had $1.8 billion in revenue but lost $1.6 billion)
• The founder, Adam Neumann, would purchase properties and rent them back to WeWork
• Neumann trademarked the word “We” and sold it to the company for $6 million
• Neumann’s wife setup a money-losing training business for the company called WeGrow
• Millions were loaned to Neumann and top executives, and subsequently forgiven
• The founder cashed out over $700 million in equity just ahead of the IPO, a blaring red alarm!
• Neumann setup his stock shares to have 20X the votes of regular shareholders
• The company had a dozen HR officials quit in just a couple of years, blaming the toxic culture from Neumann. Some complaints include: non-stop emergency-meetings and chaos, lavish parties, chanting slogans to music, all-nighter business retreats with sex-capades, and promised bonuses that were never paid
• Within hours of the document release, the company was being openly mocked, competitors began preparing to take over their leases after WeWork defaults on them, and employees were looking for an exit and getting the company name off their resume’.

As investors mulled these problems, in early September the company considered cutting the IPO valuation by 50% to prevent more investors from souring on the company. Instead, they first made a quick succession of company changes:

• Neumann’s wife, the Chief Brand Officer, was let go and removed from the board of directors, her right to name a CEO successor was removed, and her WeGrow was closed
• A new female board member was hired to turn around the company culture where there was an increasing number of sexual harassment claims by former employees
• Neumann returned the $6 million he ‘stole’ for the “We” trademark
• Neumann would resign as CEO but he would still remain Chairman of the Board
• Neumann’s share’s voting rights were reduced to 10X votes per share
• Neumann claimed he would pay back profits from real estate deals he ‘stole’ from the company
• Neumann agreed to a tiny limit on the amount of stock he can sell after the IPO

With this, the company was hoping they could IPO with a lower valuation of just $10 billion. But none of those governance changes did anything to convince any investors that the company could ever become profitable. So the IPO became unviable and was postponed indefinitely – just a few hours after Neumann recorded his video for the investor roadshow. At that announcement, some of WeWork’s bonds dropped to 7% of their par value and their credit rating plummeted two levels. Then a WSJ reporter detailed how Neumann is a big pothead and drinker, he and his wife fire employees on the slightest whim, there was wasn’t any cyber security for tenants’ data, plus 20 of Neumann’s family and friends were on the payroll for doing nothing.

In desperation for cash, WeWork is trying to sell Neumann’s G650 Gulfstream private jet for $60 million and several acquisitions the company made (but they are all money losers).

Some of this has shades of another “almost IPO” which nearly occurred back in 2015 that turned out to be a scam by a fraudster. This was the infamous Elizabeth Holmes’ company called Theranos. A silicon-valley biotech company built upon lies and valued at $9 billion until a WSJ reporter actually tried to verify Holmes’ claims about what the company was up to. It turns out, they were all false claims and Holmes’ best skill was getting soft interviews and being put on magazine covers. She was a great liar and surrounded herself with people that simply wouldn’t question her (those few that did were fired and sharply reminded of non-disclosure documents they had signed).

Everybody wants to invest in the next “disruptor” company started by someone young and hip (Apple, Facebook, Tesla, Amazon, etc.). That is fine, but remember: investors were just about to pay billions to buy the WeWork IPO – which would have gone to zero. Until you get financial statements that have been audited by an outside independent company (which was the mechanism that revealed and imploded both Theranos and WeWork), then you have no idea if what you’re buying is a polished diamond or a rotting fish.

Wait, what’s that? Another company is already trying to copy WeWork’s business model. In San Francisco, Selene Cruz raised a couple million in seed money to start a “shared retail space for tiny startups,” called Re:store. There are promotions that, “It will be a totally brand new disruptive model making a Store Front as a Service, like WeWork for retail businesses.” Maybe it will succeed, but I think that model has been around a while: like farmer’s markets, flea markets, shopping malls, kiosks, and stores with individual-company products like Sharper Image and Brookstone. I recommend avoiding gambles on “new” business models and leave that to the venture capitalists to sort out.

The race in lowering commissions is over, and the customer is the winner. Last week, the giant brokerage firm Interactive Brokers lowered their stock and option trading commissions to zero. They were quickly followed by other giants like Charles Schwab, TD Ameritrade, and E*trade. Several banks already offered zero commissions for a period of a year for new investment accounts. Unlike tiny zero-commission firms that give you very-bad price fills to survive (Robinhood, for example), these are the real big boys that now let all their customers trade stocks and options for free, from now on.

The first cautious question is, “How will the brokers make any money? Is there some dark sinister side to this?” The answer for these large brokers is ‘no’ because they all knew this day was coming, have been planning for it, and earn far more money from selling their large order flow. Most high-volume stocks and ETFs have a penny-wide spread between the bid and ask prices – and that will not change. Now that commission comparison between brokers is gone, the question now is: who has the best trading platform for you. Which one is easiest, closest to the market, and offers all of the best technology features that you are looking to employ.

I expect zero-commission trading to change the market in this one way. Since the cost to trade is now zero, some traders will experiment more with trading strategies live in the market instead of paper trading them; use more complex option positions (like 4-6 legs) that were too expensive to get in and out; and tiny profit scalping tactics may become more common. And the average trader may increase their frequency of trading and hedging. For example, if there is going to be a big news announcement (Fed meeting or employment report), it costs you nothing to buy an inverse ETF to hedge your portfolio for the day. If the announcement is at 2pm, buy some ticker symbol SH or DOG to short the general market in case of a large down move, and then sell it later before the close or first thing in the morning (to avoid day-trading violation for accounts under $25,000).

So congratulations, it now costs you nothing to trade the stock market!

There is an audio recording of personal finance expert Dave Ramsey talking about a study that he had read. This was a large study of retirees that had become wealthy and the researchers looked into the most important element that made that happen. Some of the usual suspects for building wealth for retirement are: a high rate of return on investments; low fees and costs on investments; or choosing a specific type of investment, such as stocks or real estate. None of these mattered as much as the #1 predictor of retiring wealthy.

This very important element is: how much money you add to investments each year. Obvious, of course, but most people skip right past this concept. Instead, the average investor focuses upon growing their money with unrealistic returns and beating up their financial advisers to lower their costs and fees. Or they think they will add money later, in a few years when it is easier but rarely actually do so. Meanwhile, sitting there, clear-as-day, is the simple practice of adding more money.

This exact lesson was repeatedly driven into me by my father as he built up his net worth:

• “Your return is a meaningless amount of money until you reach over $100,000 in your account, so focus on adding money and not fantasy returns,”
• “Everybody gambles and loses on risky stocks and exotic mutual funds while the tortoise passes by ALL of them. I see this happen over and over with speculators for capital gains falling behind the simple income investors,”
• “Just use prudent investments earning a stable 4-6% return and you’ll do great; passing by the stock index investors after a couple big market downturns,”
• “There is always an investing bubble-of-the-day and nearly all bubbles collapse. Just keep adding money and seek a reasonable return. Then, after the collapse, you’ll be well ahead of any average investor,”
• “Compound interest isn’t anything of note until you’re 20 years in, so you have to build up a meaningful balance well before then. Speed matters – and the fastest way to do that is adding new money,”
• “Stop looking for the quick buck and pile it up in a few solid stocks that grow their dividends, or even a stock index fund,”
• “Don’t even think of putting money into an individual stock until you have over $50,000 to $100,000. Just put your money into a safe very-short term bond fund and keep adding,”
• “The most important thing for wealth accumulation is to keep putting in money. Otherwise, you have nothing to compound over the years,”
• “Wealth is not a dollar amount, it is your perspective about how you view money and manage it. $100 can be spent on a concert ticket – or – it could kick off a new investment and habit to build an early retirement.”

This critical lesson of “keep adding money” was highlighted when a former neighbor gave me a recent update. He had retired 5 years ago but was recently forced to get a part-time job at a library because money was too tight. He says, “We had saved very little for retirement and unexpected expenses were killing us.” Since he had earned a very-good salary, his lack of retirement savings was not due to a lack of income or some hardship; it was because of his spending priorities. (This is common: 68% of Americans age 55-65 have less than one year’s salary in a retirement account). It is my best advice that you make it your priority to continually add new money to your investments.

In the long, long ago, when a stock, industry, or the overall stock market fell in price, there were bargain hunting investors willing to step in and purchase shares once they fell low enough to be a good deal. Today, passive investing into index funds accounts for over 40% for all stock institutional trading – and this percentage is rising. When passive index investing grows well beyond 50%, there is a new and substantial structural risk slowly being drizzled upon the portfolio of unknowing investors.

There are several reasons why an index fund may need to sell their shares of a stock: company names are added and deleted from indexes all the time, individual or institutional investors may sell their fund shares, forcing the fund to sell stocks to free up cash, to name a few. Now, imagine a scenario where the increasing trend toward index investing grows for another 15 years. Perhaps by then 90% of all stock shares are traded by index funds. In this future scenario, a company named XYZ is removed from a major index. Then, 90% of market participants will be trying to sell their shares at the same moment but only 10% of the entire stock participants are even available to buy any of it. The price of XYZ shares must plummet and may be in a freefall because there simply isn’t enough money available to support the old stock price. Now, what about other scenarios where index fund managers decide to get out of an industry or reduce their exposure to the whole market altogether – again, we’ll have a plummeting sector, or stock market, with no index-fund manager using reason to make a purchase.  

This is because passive index investing requires active money managers to generate “price discovery.” It is only this free-market price discovery that creates a fair price. If passive index investing dominates the stock market, then there is no one left to create a fair price; so what remains is price instability and unfair pricing (meaning prices far above and below a reasonable fair-market value). I won’t add algorithmic trading to this caldron today, but you can correctly guess that it does not add price stability.

If passive index investing continues to increase their market share, is there anything we can do to lower our exposure to a potential for flash crashes? Yes, there are two ways to hedge your portfolio:

1. The simplest way is to move some money from stocks and bonds to cash and gold. It is a personal decision to determine a correct ratio for your portfolio, but consider holding 10%-25% of your money out of riskier stocks and bonds into cash and something non-correlated like gold and silver.
2. Employ a “Risk Parity” method of portfolio construction. A common asset allocation model could be something like a portfolio made up of 70% stocks and 30% bonds. Risk Parity uses math to evaluate how much risk you have added to the portfolio with each asset component. For example, your portfolio’s components may be stocks, bonds, real estate, commodities, and cash. Perhaps your stocks add so much risk that to equalize its portion (parity), you should only have 24% of your portfolio in stocks. This method is something you can learn about online, but just consider that most money managers consider “managing risk” one of their most important priorities.

The future scenario of stocks plummeting from index fund activity 15 years from now may never occur. However, the more knowledgeable you are as an investor, the more you can prepare your portfolio from any potential risks on the horizon. If you can partially sidestep just one market downturn, you’ll be miles ahead toward your financial goals.