Risk-Management in Your Mutual Fund: Paradigm Capital Management

The disappointment that a mutual fund quarterly statement can hold is a big fat minus sign in front of the earnings amount and a lower balance than in the previous quarter. No matter how well the market does, inevitably there will be a downturn. Fluctuation in value is one of the axiomatic truths about the stock and bond markets.

How does one develop the tolerance for accepting market risk?

For some people, the answer is that they can never become accustomed to the changes. Let’s be clear. There is no need to tolerate the increases in account value reported on a statement. The upturn is welcomed with open arms, a smile and a feeling of self-satisfaction: the market gods have been good. What makes the ensuing decline so difficult for many people is the focus on the account balance from a good quarter as a chiseled-in-stone fact. When the poor performance occurs, the complaint rings forth: “I lost money in the market.” It’s almost as if a burglar stole cash from a locked safe. The investor has a feeling of ownership which is reinforced by the observation of numbers typed on his or her statement.

A quarterly statement of account is merely a snapshot of an economic moment in time. The values of all the shares in the fund are calculated as of the last business day of the quarter. The mutual fund then attributes that value to your ownership amount. Then a comparison with the same figure from the previous quarter produces a number that is higher or lower. What does it really mean? The only meaning is that most mutual fund companies send out quarterly statements based on the Julian calendar. If the statement were issued one week earlier, the ending balance might actually have been higher or lower–the market happens daily. Sometimes it may be better for a long-term investor to ignore the quarterly statements and just check the annual statement.

One must understand that stocks are shares of ownership, or equity, in businesses. The market value of any business changes because of optimism, pessimism, market share, sales, costs, competition, interest rates, amount of debt, buyout offers, public demand to own shares, scandals, industry boons or misfortunes, rumors, reputations, new products or services, and too many more factors to mention. With all of that taken into account, there are still people who believe that ownership of a business is a prudent risk. If you are one of those people, you are looking at more than your quarterly statement and have a long-term view.

Here are some practical steps suggested by our experts at Paradigm Capital Management that a conservative investor can take to moderate risk, keeping in mind that risk will always be present:

  1. Choose a fund with a conservative investment objective. The Securities and Exchange Commission requires mutual funds to state their funds’ objectives in their prospectuses. Read the prospectus. See if you are comfortable with the fund’s investment objectives and attendant risks.

  1. Dollar-cost-average your investment into the fund. Buy shares each month through an automatic investment plan which most funds offer. Some months the share price will be higher, some months lower. Over time, your cost will be the average of all the prices that you paid. When the market price is lower, your monthly deposit will buy more shares and fewer shares when the price is higher. The averaging does not eliminate risk or prevent loss. It merely keeps all the assets from having the same cost. The expectation is that over a longer period the average cost will be lower than the current price.

  1. Consider choosing a fund that pays dividends. Dividends payments represent the method through which companies share profits with shareholders. Although dividend payments can change, and are not guaranteed, they are an immediate investment return to the shareholder from company profits. This profit is distinguished from the equity value or share price at which the company is bought or sold. If a company does not pay dividends, your investment profit would rely only on the increase in equity value. Dividend payments can be reinvested automatically to purchase additional fund shares.

  1. Look at your fund’s portfolio. See what companies are included. Remember that you indirectly participate in the ownership of those companies through your shares of the fund. Consider how you feel about the economic sectors represented and whether you like the company choices made. Find out more about the fund management strategy and methods. Never forget that you are an owner. Your status is different from a depositor in a bank certificate of deposit. Understand what you have.

The best idea is to learn to love the risk. Appreciate the opportunity. The stock market provides an individual with the ability to participate in the national and international economies in a meaningful way. Where else can someone be part-owner of something so grand? These public companies are large commercial and industrial concerns that few of us could ever hope to start ourselves. These businesses provide the world with goods and services.

Paradigm Capital Management is a trusted leader in small cap investing and employs a disciplined, bottom-up approach with an emphasis on fundamental analysis and extensive management contact.

The Paradigm Funds family of no-load mutual funds makes the firm’s small-cap and SMid-cap strategies available to fee-based financial advisors and retirement professionals. Paradigm Funds are widely available on more than 50 no-load platforms.

To learn more about how our capabilities align with your long-term goals, please contact us at (518) 431-3500

Also read: Conservative and Aggressive Mutual Fund Investment Banking

 

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