How To Approach Investing Amid Current volatility? Remember Risk Management?

Volatility has hit the market suddenly, and it's time for investors to shift from strategies that have worked over the past few years.

We're experiencing a tsunami of uncertainty with daily changes in trade, economic, immigration and political policies that feel at times like waves crashing on shore and currents flowing in multiple directions. Outside of the 2008 financial crisis, I have not seen this level of uncertainty in the world and markets in my 20 plus years in investments.

Tsunamis won't last forever, and this one won't either. We have no way of knowing what the world will look like afterward, yet clues such as the sudden declines in the Magnificent Seven may hint at what's in store. Regardless, the environment is changing and thus a new approach is needed.

Remain flexible — don't be married to your beliefs

They say investing requires conviction to ride out the storms. But in this environment of massive uncertainty, clinging too tightly to a deeply held belief can actually get you in trouble. For example, investors believe AI will be transformational, and they may be absolutely right in the end. The question is, are their strong beliefs that Nvidia and Microsoft will be the undisputed winners correct? That is harder to predict, and conviction can be hard to hold when the stocks have all come down quite a bit.

A macroeconomic example might be believing that the Fed is going to cut rates. With so many variables affecting the economy and inflation — tariffs, consumer sentiment, unemployment, corporate earnings, etc. — even in the short term, it is difficult to predict timing, magnitude and direction. Betting your portfolio on one direction or another may not work out as you might expect. 

The market is more unpredictable than it has been in the recent past. Staying nimble and humble can help you navigate the changing world.

Risk management is important — how much can you lose?

Risk management is much more important today than it has been in years. As recently as a few months ago, an investor might have looked at a company and said, "Oh, it’s a really great company. If I buy and hold it for a long time, I’ll be fine. Its valuation doesn’t matter." In times of greater uncertainty, valuations can matter and do. This is one reason we've seen highly valued stocks underperform this year.

It might be better to ask, "What is the probability that I lose here?" Of course, conventional wisdom is that this should always be your first question. But for many investors over the past few years, it wasn’t. We've gone from asking questions like, "How much can I gain if I buy Nvidia now?" to "How much can I lose? Should I have better diversification?"

A lot of investors haven't exercised the risk management muscle in a while, because they didn't have to. If you bought tech stocks starting around 2010, you’ve made a ton of money. If you didn’t sell, that was the right call. But now a stock like Apple might be massive in your portfolio because it's only gone up. Should any one stock, including Apple, be 10% of your portfolio? In today's market, that could be risky and lead to losses.

Am I protecting my purchasing power?

Preservation of capital is, of course, fundamental. Everyone knows Warren Buffett’s rule: "First, do not lose." A corollary in the current conditions should be: Protect purchasing power. Success is not just avoiding loss; it's also about maintaining the standard of living you expect. As inflation erodes away the value of a dollar, you need your wealth to compensate by growing faster than inflation.

This could mean thinking about diversification and asset allocation differently. With long bonds earning 4-5%, if inflation is 3-4%, you may have protected your principal, but perhaps not your purchasing power. You might feel poorer and poorer over time because your dollar is buying you less. I believe that the current fiscal situation encourages those in government to lean on inflation to address our national debt, despite the cuts we're seeing to get the deficit under control. This could mean more high inflation and that maintaining purchasing power will be more important than ever before. 

With heightened uncertainty caused by the ever-changing geopolitical and economic landscape, investors really need to focus on staying flexible in managing investments with a strong focus on  risk management. This is the only way to preserve capital and protect purchasing power at the same time.