RORO isn’t what George Jetson’s dog used to say. It’s trader jargon for “risk on/risk off.” Investors pile into risky assets — especially stocks, both U.S. and foreign — when the economic news is bright, and run for cover into Treasuries at the first whiff of trouble.
Even if you’re a steady buy-and-holder, RORO has left its mark in two big ways:
First, diversification is harder. A classic way to reduce your volatility is to own different kinds of assets, so that when one part of the market falls, something else may be going up — or at least falling less. RORO wrecks that. It first roared in the 2008 crisis, when not just U.S. stocks but foreign stocks, high-yield bonds, real estate, commodities, and you-name-it all crashed.
The HSBC RORO index, which tracks how closely assets correlate, or move together, kept rising from there. It stayed near historic highs through late 2012.
The mood-swing trade has tailed off this year, but that’s because U.S. stocks boomed as Europe and emerging markets dragged. So spreading your bets with international stocks didn’t help you in the crisis and isn’t boosting your returns now.
In any case, it’s too early to declare an end to RORO, says HSBC strategist Mark McDonald. With the global economy still vulnerable to crisis, a raised eyebrow from Ben Bernanke or a European finance minister may be enough to set off an undiscriminating tizzy. “Any market hiccup can cause correlations to spike again,” says McDonald.
Second, safety is getting risky. One investment that has smoothed your ride is the safe haven everyone runs to at “risk on” time: Treasuries. They’re now so popular that the yield on a 10-year note is down to less than 1.8% (When bond prices rise, their yield falls.)
That creates some problems: Yields have little room to go anywhere but up from here, which means you could experience sharp losses when interest rates, and thus yields, start to rise again. What’s more, holding bonds at these rates means you risk seeing your investment’s value eroded by even a moderate amount of inflation.
How, then, in this twitchy environment, do you build a portfolio safe enough to let you sleep at night, with returns that get you to your goals? MONEY dove into the best research on diversification and talked to some of the sharpest advisers. The big takeaway: With only a few twists, you can still hedge against the risks that really matter.
What follows are five key ideas to guide a long-term investor through a market where everything turns on the latest news flash.