Volatile markets like these always remind me how much personal wealth can be gained or lost from hysterical or knee-jerk decision making. When 2-4% gaps become common place; the feeling of “investing” quickly goes out the window, and that empty space begins to fill with speculative or “gambling” urges that can work either for or against our day-to-day psyche. 

Unfortunately this week many investors had to bear the brunt of a 20%+ decline in their holdings; mostly stemming from ETFs that became severely detached from their respective NAVs as downside momentum took hold during Monday’s opening rout.  Those paper losses reluctantly became realized losses as stop-loss triggers were tripped, and volume spiked in tow.  Even more shocking is that the products that exhibited this behavior weren’t small, illiquid, or obscure products, but rather big diversified offerings from sponsors such as Vanguard, iShares, or Powershares.

Yet that wasn’t the first time we’ve witnessed price anomalies like this in ETFs; on May 6th 2010, ETF prices alongside their respective bid/ask spreads became acutely distorted.  What was later known as the “flash crash”, should have given investors a stern warning that hard stop losses on ETFs don’t get filled in an orderly fashion in a disorderly trading environment.

As a result, the entire concept of risk management gets pulled into the spot light, especially for performance chasing or trading portfolios that simply got caught off sides with too much exposure or leverage.  Furthermore, it’s important to note that stepping aside during the throws of quick downdraft in equities isn’t ever a smart decision, and certainly isn’t the definition of risk management.

From my perspective, true risk management is avoiding investments that lie outside your individual goals, mandate, or tolerances.  Secondly, managing opportunity cost is the other side of managing risk.  Putting a strategy in place to effect positive changes to your portfolio during a difficult market will always improve your investment outcome when solid opportunities arrive.

Conversely, in my opinion, real risk taking is using stop losses as some sort of systematic false sense of security, or acting out of emotion when the market may be at its most desperate point.  It will take you much longer to recover from these types of decisions then simply framing your risk appropriately and implementing a strategy decisively.

For example, at our firm, we weren’t selling bonds for our clients during the interest rates rise in the May-June time frame, we were buying them.  Even though at the time, the risks that rates “could just keep on going” might have been equally compelling.  Similarly, we weren’t selling equities during this true-to-its-name market correction, in fact we were buying.  The difference is, we don’t allow ourselves to succumb to emotion, and we use our research to seek out common sense areas that will add value to our portfolios in the intermediate to long term.

If you did the opposite and capitulated this week, you may be proven correct with time, just like all well publicized market pundits that are always the loudest when the market jives with their prognostications.  However, you have to ask yourself the question: Did you truly do your portfolio justice and add value for the intermediate to long term, in spite of being able to buy back in at a lower level?

My point isn’t whether you were able to time the market perfectly, and self admittedly we sure didn’t, but we were able to invest money at what we believe to be good solid long term value.  Then make the ultimate decision at a later date to reduce exposure if and when the market becomes over bought.  That is the key to selloffs and managing risks alongside opportunity costs. It’s about staying true to your personal investment mandate, not stepping outside your comfort level, and maintaining your perspective in light of the fear and greed cycle.