A Message to Cautious Investors in Today's Environment

A Message to Cautious Investors in Today's Environment

July 25, 2022

A Message to Cautious Investors in Today's Environment

Key takeaways

   Many cautious investors are scared, which is a rational behavioral response. Given the overarching questions about capitalism and political freedom, many are rightfully fearful about the uncertainty ahead.

   When it comes to investing, we can't predict, but we can prepare. Preparation helps us deliver on an objective and reduce risks, ideally keeping up with inflation. Cash might feel safe, but it is generally ineffective as a long-term holding to keep up with inflation. Bonds carry slightly more risk, but they are more likely to deliver on goals and retain your purchasing power.

   The key is to understand what we can control and position ourselves in assets that give you the highest likelihood of reaching your goals. In a forward-looking context, defensive investments such as bonds are expected to continue supporting goals. We seek a steady journey but must expect modest setbacks, which sow the seeds for the future.

Politics, war, and a cost-of-living crisis are all pressing on the moral conscience. Retirees are particularly scared, with inflation pinching budgets at the same time as portfolio values struggle. Additionally, the uncertainty created by the political upheavals in western democracies, together with the longer-term impact of the COVID pandemic and the war in Ukraine, have eclipsed the financial characteristics of the investments that people own and directed their attention towards politics and security. The impact is confidence-sapping.

This can be seen in the returns to investors over the year-to-date and is especially evident in two assets. The first is government bonds, which are typically held for their defensive characteristics and as a source of diversification when investor sentiment is less positive. The second is the share price movement in U.S. companies that were expected to grow rapidly—including technology stocks—which have been the main engine of returns to investors over the last few years.

Unusual Features of Today

Unusually, government bonds have not played a defensive role in 2022, but have instead fallen in price alongside equities. While this synchronized decline will have a limited impact on more adventurous investors, who typically hold few bonds in their portfolios and are familiar with the ups and downs of being a shareholder, it is likely to be of far greater concern to cautious investors who typically hold a much greater proportion of their portfolio in bonds and are used to a more stable return.

The combination of unusually poor returns and a troubling geopolitical backdrop is a perilous one for investors as it can promote behavior that may permanently damage an investors’ ability to reach their financial goals. We understand the allure of cash-reigns-supreme at times such as these (the so-called "cash is king" mentality), but it is important to remember that cash has a terrible track record of keeping up with inflation, so is a near-guaranteed way to lose purchasing power.

Given the above developments, we have three points we'd like to convey to help guide clients through this challenging period.

1. Keep Returns in Context

As humans, we have a tendency to concentrate on our most recent and vivid experiences and extrapolate those experiences forward. This leads us to be more adventurous when we have recently experienced gains and more cautious when we have experienced losses. It also explains the habitual problem of investors buying high and selling low.

One way of combatting this tendency is to contextualize recent returns as part of a longer-term journey towards an investors goal. For instance, the returns to cautious investors have been very healthy over the last few years (higher than long-term norms), supported by relentless stimulus from central banks that propelled both bonds and stocks. As a result, cautious investors are likely to be far closer to their original goals than they might expect to be at this point, notwithstanding the recent falls.

Cautious portfolios are still in good shape for the future, too. The change in the market in 2022 has seen yields increase across the board, which sows the seeds to future cashflows and returns. This is especially true for bond markets, which are an effective holding for cautious investors from today's position. We are deliberately targeting assets that offer healthy and stable investment profiles, which should give you confidence. If you have a decent investment horizon, there is reason for optimism.  

2. Take Back Control, but Do So Effectively

The loss of control that one feels when asset prices are falling can be anxiety-inducing. Yet it is important to acknowledge uncertainty for what it is. Uncertainty is everywhere, given geopolitical events that are both unpredictable and impactful, such as political division, a cost-of-living squeeze, and the threat of war.

The desire to control is a natural response, but it is perhaps better diverting that focus to matters that are likely to improve your situation. Budgeting is one such example that is worthy of revisiting in today's environment, as it has likely changed. With inflation impacting some parts of your budget more than others, it is a good idea to work through your spending patterns and identifying actions that can improve your financial situation and provide reassurance.

We are similarly looking at the impact of inflation on different investments, with some sectors and countries more impacted than others. Adapting to change while controlling the controllable is a sound approach to decision making. But trying to control the uncontrollable leads to destructive actions. As Warren Buffett famously said: "Only when the tide goes out do you discover who's been swimming naked." Understanding uncertainty, robustness, and control are key concepts we take seriously as investors.

3. Reaffirm Your Goals

Progress towards one’s goals is only relevant if the goal is well articulated and sticky. That is, we want to get to the heart of your ambitions and maintain our focus over time. And while many are thoughtful about this process, we often hear that clients' goals change amid uncertainty. Even worse, those without goals are far more likely to be focused on recent returns and therefore more prone to the mistakes that such a focus encourages. Equally, it is challenging to reassure that you are financially secure if you do not share a definition of what financially secure means.

In order to help, we encourage you to work through a process that we call "mining for goals." This process was developed by our Behavioral Insights team and involves three steps; 1) writing down your top medium- to long-term goals off the top of your head, 2) reading a list of the most common goals among similar people, 3) reassessing which goals are most important to you. Our research1 found that over 70% of people changed at least one of their top three goals as a result of step 2, helping them understand what is most important and helping create a stickier foundation for success.

Of course, if your goals have changed, this may require a rethink of your financial plan. It may also impact the investments that are most appropriate for your circumstances. If this applies to you, it should be worked through with your financial advisor.

Our Message to Cautious Investors

From an investment perspective, the principles of good investing still apply, and we feel positive about our ability to help clients' reach their goals despite the market backdrop. As part of this, we continue to manage risks carefully, understanding the impact of inflation and recessionary conditions on each investment we hold. Today's conditions bring about new challenges, but our north star hasn't budged—with our clients' goals top of mind. The silver lining is that our return expectations have improved following recent market weakness, which should hold investors in good stead over the longer term while we seek robustness at the total portfolio level to manage against headwinds.

1 https://www.morningstar.com/lp/mining-for-goalsWhile periods such as the one we are experiencing are undoubtedly challenging for cautious investors, we want you to know that we are thinking carefully about your journey as investors and as humans. As ever, we are here to support you in any way that we can.

The indexes noted are unmanaged and cannot be directly invested in. Individual index performance is provided as a reference only. Since indexes and/or composition levels may change over time, actual return and risk characteristics may be higher or lower than those presented. Although index performance data is gathered from reliable sources, Morningstar Investment Management cannot guarantee its accuracy, completeness or reliability. S&P 500 Index: Market-capitalization-weighted Index of 500 widely held stocks. Member companies are chosen based on market size, liquidity, and industry group representation. Included are the stocks of industrial, financial, utility and transportation companies. S&P 500 Communication Services & Information Technology Index. The index1 measures the performance of companies in the S&P 500 classified as part of the Communication Services and Information Technology sectors. Company classifications are based on GICS. For more information on GICS, please refer to S&P Dow Jones Indices’ Global Industry Classification Standard (GICS) Methodology. Opinions expressed are as of the current date; such opinions are subject to change without notice. Morningstar Investment Management shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment. Performance data shown represents past performance. Past performance does not guarantee future results. All investments involve risk, including the loss of principal. There can be no assurance that any financial strategy will be successful. Morningstar Investment Management does not guarantee that the results of their advice, recommendations or objectives of a strategy will be achieved. This commentary contains certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason. Past performance does not guarantee future results. Morningstar® Managed PortfoliosSM are offered by the entities within Morningstar’s Investment Management group, which includes subsidiaries of Morningstar, Inc. that are authorized in the appropriate jurisdiction to provide consulting or advisory services in North America, Europe, Asia, Australia, and Africa. In the United States, Morningstar Managed Portfolios are offered by Morningstar Investment Services LLC or Morningstar Investment Management LLC, both registered investment advisers, as part of various advisory services offered on a discretionary or non-discretionary basis. Portfolio construction and on-going monitoring and maintenance of the portfolios within the program is provided on Morningstar Investment Services behalf by Morningstar Investment Management LLC. Morningstar Managed Portfolios offered by Morningstar Investment Services LLC or Morningstar Investment Management LLC are intended for citizens or legal residents of the United States or its territories and can only be offered by a registered investment adviser or investment adviser representative. About Morningstar’s Investment Management Group Your investment goals matter to us. Our mission is to empower investor success by building investment portfolios selected by your financial advisor. Our world-class investment strategies draw on our core capabilities in research, asset allocation, investment selection, and portfolio construction. Our Page 9 of 9 Page9of9 Page9of9 Page9of9 The 2022 Selloff: What, Why, and Where We Stand | May 2022 investment professionals are located around the world, which provides both a global point of view and local market expertise. Based on a proprietary valuation-driven asset allocation process, our strategies offer investors a range of multi-asset risk- and outcome-based strategies designed to help meet a variety of goals. Also, our separately managed accounts offer concentrated portfolios of our portfolio managers' best ideas. We put more than 35 years of investment experience to work in every portfolio we manage to offer you a better investing experience, because your journey also matters.


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