Does Wall Street even care?
by Steve SelengutMr. Selengut is a private investor and a contributing editor to Advisor Magazine. He is the author of the book ‘The Brainwashing of the American Investor: The book that Wall Street does not want you to read.’ He can be reached at firstname.lastname@example.org
I’m not sure that all investors understand and/or appreciates the distinction between “market risk” and “financial risk”. Market risk is a feature of any security, its driving forces are diverse and mostly unpredictable. Just think about the various political, economic, medical, natural, interest rate, and social issues that have rocked market values over the years. Long term (the last 50 years) none should have had a serious impact on Working Capital.
Financial risk is what the risk pyramid is all about… the likelihood that the security in question will cease to exist through bankruptcy or some other business or government failure. In its original form, the pyramid dealt only with individual securities, and even Wall Street (in moments of weakness) has admitted that portfolios of securities are “financially” safer than each security is individually.
Treasury bills, for example, carry practically no financial risk.. thus their low yield. However, their market risk is as significant as any other rate sensitive security. CEFs that contain more than 40 individual (multi sector) securities minimize the financial risk considerably, but do little to change market risk… other than turning it into an opportunity.
Market Values: Transitory At Best
Another way of looking at it is that market risk (price movement to a lower level than your cost basis) is universal while having zero impact on your Working Capital. Financial risk (a function of QDI) is a much more serious foe, but one that can be minimized so that it is less likely to deplete capital. Market values should only be used for buying and selling decisions as they are transitory numbers at best. That’s right, not for asset allocation decisions.
- It should also be remembered that market value growth itself (and the market value portion of total return) cannot be spent unless and until the profits are taken, and that the growth numbers themselves do little to increase either working capital or realized, spendable, income.
Finally, both financial risk and market risk are minimized by the natural diversification and income production that managed, multi security, portfolios provide. Interest rate risk compounds market risk for all securities while imposing more financial risk, most seriously, on the lower quality sectors of both income and growth purpose individual securities.
- Note that neither ETFs nor Mutual Funds are managed portfolios, ETFs by intent and MFs at the times management is needed most… during greed and panic attacks by shareholders. Closed End Funds are always professionally managed and are designed to produce spending money, not growth in market value.
Market risk can be dealt with productively; financial risk must be minimized intellectually. In a sensibly managed (add the disciplined PT to the QDI) CEF portfolio, market value fluctuation can become your VBF while financial risk becomes a weird uncle who has totally lost contact with your investment family.
Q = selection quality; D = multiple types of diversification; I = income production; PT = profit taking.