Identifying risk in a bull market: The fundamentals of protecting yourself
Written by Steve Ciaccio, MBA, CPA, CFP®
When a bull market advances for long periods of time, some people begin forget that risk continues to exist. How do you identify risk in a bull market? As a starting point, you might want to consider these two questions:
How much longer will the bull market last? A common misconception is that all bull markets continue to move upward as long as the economy continues to grow. In some cases, bull markets have ended several months before it was evident that the economy was beginning to contract. Why is this? Among many reasons, sometimes stocks begin to lose value in a growing economy because investors believe that the stock price increases have outpaced economic growth and future expectations. This can cause investors to sell the stocks and thus move the stock market indexes downward even though the economy is still strong at that point. Another potential reason is that, with the economy growing, investors might anticipate that the Federal Reserve Bank will increase interest rates at some point in the future to slow economic growth. As a result, investors might sell their stock holdings months in advance of an anticipated interest rate increase, thus putting downward pressure on the stock markets. There are many other factors that affect the interplay between the stock markets and the economy. The main point is that sometimes bull markets end even while the economy is believed to be growing at that time.
Will your individual stocks rise with a bull market and fall with a bear market, or will they perform independently? Many stocks have moved upward or downward to some extent simply because the major market indexes have done the same. This is called systematic risk. Many websites publish information regarding the volatility of stocks relative to market movements. That is only an indication of past performance and not necessarily an indication of the future relationship to overall market movements.
Another factor is the portion of the stock’s price performance that is not related to the overall market or economy. This is known as specific risk. Specific risk relates to many factors such as the life cycle of the company’s products or services, company leadership, financial strength, innovation, competitive advantage, growth outlook, and many other factors. Many stocks have a combination of systematic and specific risk. These factors should be understood prior to investing in a company’s stock.
So, now that we have identified these risks, how do we manage against them as well as other types of risk that exist? One of the many answers is to diversify, but there are many risks to manage and many ways to diversify. The cost of diversifying (commissions and fees) is also an important factor. In our next article, we will discuss some simple and cost effective methods of managing some of the risk of stock investing.
Food for thought: Increasing your knowledge has the potential to increase both your performance and your comfort level in your endeavors.
All the best to you!
Steve Ciaccio, MBA, CPA, CFP®
Steve Ciaccio, MBA, CPA, CFP® is the founder of Ciaccio Wealth Management, Ltd., located at 232 South Batavia Avenue, Batavia. He can be reached at 630-454-4599, Steve.Ciaccio@LPL.com. The opinions voiced in this article are for general information only and are not intended to provide specific investment advice, tax advice, or recommendations for any individual.
Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC. Stock investing involves risk including loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Copyright Steve Ciaccio 2018