“We’ve had three 100-year floods in the last 18 months. This one looks like a 1,000-year flood.”
– Congressman Pete Olson of Texas (source: NPR)
The historic amount of rainfall caused by Hurricane Harvey last month caused flooding in the city of Houston. This storm marked the third flood event to hit the Houston area in as many years (Memorial Day floods in 2015 and 2016 accounted for the first two).
Every time I read or hear about sophisticated assumptions about future weather patterns I am reminded of the computer models used to predict stock market risk.
The current generation of robo-advisors use Modern Portfolio Theory to construct individual company 401(k) retirement plan mutual fund portfolios with the lowest possible risk.
Just in case you are interested, the financial industry jargon for the lowest possible risk for a given level of expected return is standard deviation.
The robo-advisor “sales pitch” for Modern Portfolio Theory is that it will weather any stock market storm in a company 401(k) retirement plan account. This investment management process will “diversify away” potential historic company 401(k) retirement plan principal losses.
If you are a long-time resident of the Houston area, you have been warned on three separate occasions over the last few years was to evacuate areas of the metro. For those few citizens who lacked those skills, mandatory evacuations were ordered.
If you choose to live in Houston, you will live to see more historic flooding. You can’t diversify your way around that fact. At some time in your future another evacuation will save your life.
Fortunately, there are equally sophisticated computer model tools that will help individual company 401(k) retirement plan participants identify heightened risk levels in changing stock market environments.
These tools don’t rely on historical correlations. Instead, they help identify the realities of lower stock prices caused by more sellers than buyers. These tools don’t have to predict. They just need to react to what is going on in the stock markets.
It is much too late now for Houston residents to buy flood insurance. Just like it is much too late for Florida residents to buy hurricane insurance. It is not too late to put in place a stock market risk management game plan for your company 401(k) retirement plan account.
Computer models can provide more than enough time to alert you to “get out of the way” when you need to. Diversification does not get you out of the way. Instead, you sit and take it and hope for the best.
Make sure that you have more than enough time to safely evacuate with a large part of the last several years of your company 401(k) stock market investment gains.
Ric Lager
Lager & Company, Inc.
