The Wallenda Dilemma
Nik Wallenda recently completed a 1300 foot tightrope walk 25 stories in the air over Times Square in New York City with his sister Lijana which ABC televised on June 23rd, 2019. This walk adds to Nik’s already death-defying and amazing portfolio of tightrope walks. While the list is too long to mention all of his accomplishments, the most notable are his walks across the Grand Canyon and Niagra Falls. Most of these walks use no safety equipment at all, and the slightest miscalculation or slip could result in disaster for Nik. From the time that he could barely walk he has been involved in acrobatics and is the seventh generation member of the famous Flying Wallendas. Their history is marked by triumph and tragedy as many of them have been seriously injured or died in falls. When asked after the Times Square walk what he wanted to do next, Nik said that he wanted to walk over the mouth of an active volcano!
Nik Wallenda walking across Niagra Falls in 2012
While not as death-defying or exciting to watch, Federal Reserve chairman Jerome Powell reminded me of a Flying Wallenda during his press conference last week. The Federal Reserve decided to lower interest rates after the recent bout of growth concerns and despite a healthy U.S. labor market. This is the first rate cut in eleven years and could mark the beginning of a concerted effort by the Federal Reserve to cut rates further should conditions warrant. Much like a tightrope walker, the Federal Reserve is attempting to balance its mandates of low inflation and full employment at the same time. The third unstated mandate is to ensure financial market stability by communicating well ahead of time the intention of long term policy actions.
After receiving criticism for having raised interest rates too high despite low rates of inflation, the Fed appears to be at a crossroads where if the U.S. economy slides into recession they will receive much of the blame. In walking this tightrope, the Fed is hoping that lowering interest rates will allow the economy to continue to grow without risking an uncontrolled rise in the inflation rate down the road. If past is prologue, the chances of them pulling this off are low, but as investors, it is impossible to predict the future.
But unlike a Flying Wallenda, we as investors can choose to use safety equipment in our portfolio to help protect against a dramatic fall if the Fed slips off their tightrope and the stock markets fall with them. How we do this in our portfolios is to balance the amount of risk that we are taking between stocks and bonds. Specifically riskier stock holdings should be stabilized by less risky bonds to create a portfolio that will be able to withstand the ups and downs in the market without falling off our tightrope on our way to financial freedom.
Since bonds are historically much less volatile than stocks and tend to rise when stocks fall they are the primary way in which investors manage the potential downside risk in their portfolios and earn a small return along the way. The chart below illustrates what kind of performance a mix of stocks and bonds experienced during the Great Recession.
If you are already retired, you will likely have a more conservative allocation as you are nearing the end of your financial plan, but for younger investors, with more time they usually can take the additional risk without having to worry about falling off their financial tightrope. They might wobble more along the way, but they possess the time and earnings power to regain balance before they reach their goals. Understanding this balancing act can help investors manage the amount of risk that they are taking in their portfolios and stay on their tightrope to financial freedom.