Council Post: Why Innovation Has Created An Investor’s Conundrum And How To Adapt

Independent SEC-registered investment advisor at Stonnington Group, a wealth management and investment planning firm based in Pasadena, CA.

Innovation is quickly becoming a dominant economic force. This has only been super-charged by Covid-19. Investors are chasing companies that are developing cutting-edge technologies with the potential to help people cope with the pandemic’s massive disruption and even prepare for future black swan catastrophes. From digital tools that facilitate remote work and telemedicine to services that allow people to socialize and shop for groceries without leaving their homes to lifesaving pharmaceuticals and breakthroughs in vaccine development – transformative technologies are all increasingly desirable investments. 

Innovation isn’t just changing the way we live and work; it’s also reshaping the way we think about smart investments. Historically, the predominant conservative strategy was to invest in large market capitalization companies that have already achieved market dominance. Recently, however, companies that are growing quickly are proving to be better investments. While value stocks may see a renaissance over the next 20 years, that window will likely close as a shrinking population demands new sustainable technologies and growth stocks deliver the most benefit. 

Furthermore, this shift is happening in an environment where interest rates are essentially 0%. Historically, a conservative investment strategy would promote a blended portfolio with bonds, but as interest rates rise, bonds may expose investors to the risk of losing market value without the opportunity to offset that risk with current income.

It seems as though the same innovation making the world go round is also turning the world upside down. In an almost complete reversal of historical precedent, the risk of buying high-quality value stocks and diversifying into high-quality bonds may now be greater than the risk of investing in companies that are already appreciating based on future earnings growth potential. 

This is the modern investor’s conundrum, which raises essential questions. Is it now actually more conservative to invest in companies driving innovation with high growth potential? And, if so, are these investments appropriate for every investor? Here are a few ways investors might rethink old paradigms in this new world order. 

Considering A Higher Risk Profile

Investors need to consider whether they’re working to protect their principal or working to grow their principal. In order to grow principal in today’s market, where the investments that pay and return the most are those with the highest future earnings potential, investors may need to embrace higher risk than before. 

But what about investors who are living off of a portfolio that they can’t afford to lose because they cannot replace it? For retirees and people who are no longer able to contribute to their portfolios but, instead, must take money out, assuming greater risk might sound like a bad idea at first. However, when done in a diligent and conscientious manner, it can significantly improve the outcome of the portfolio. 

Rethinking Dollar-Cost Averaging

Historically, one of the most powerful investment strategies has been dollar-cost averaging. By routinely investing in the market at a fixed-dollar amount, investors buy fewer shares when they’re more expensive and more shares when they’re less expensive to achieve a lower purchase price over time. However, this strategy works in reverse when taking money out of a portfolio. Taking out more shares when prices are lower and taking out fewer shares when the prices are higher can significantly undermine a volatile portfolio.

Higher risk securities that increase volatility may not be appropriate for investors living off of their portfolios. However, a portfolio that isn’t appreciating may not be enough to live off of either. On the one hand, investors might decide to take on risk that could potentially hurt their portfolios; on the other hand, not taking on risk and staying stuck in a portfolio that isn’t appreciating is a definite prescription for lowering its value. 

Rebalancing Asset Distribution

This might feel like being caught between a rock and a hard place. But there are ways to navigate this new space. Investors may want to invest in high-quality companies that are positioned to grow over time while reserving a portion of their portfolio for low-volatility investments available for distribution. In order to avoid depleting risky investments with high growth potential when they’re down, it’s important to have a savings account from which to pull without damaging the portfolio.

This is a different model than the model investors followed in the past, where the idea was to diversify in meritorious asset classes. This is because it is fruitless to diversify in asset classes that either aren’t appreciating and paying income or don’t have the potential for appreciation.

The key is to invest in innovative companies that are well positioned for growth and companies that can not only survive a recession, but can consolidate market share during a recession to come out stronger on the other side. For this reason, it has probably never been more important for investors to work closely with an advisor who has expertise in constructing portfolios that have potential for future growth. 

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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