Getting “Stressed” Can Be Good for Investors

Robert Blake, PhD.Analytics, Risk Management

After the financial crisis and its infamous bank bailouts, US government regulators got tough with banks, demanding proof that their financial positions were strong enough to withstand another financial crisis before being allowed to distribute any profits to their shareholders. The Federal Reserve, for example, required banks to pass annual “stress tests” in which banks must estimate how much money they would lose if the 2008 crisis—or something similar—were to strike again. Because banks (like the overall economy) are now much stronger than they were back then, the latest stress test results – scheduled for release on Thursday – are expected to earn the Fed’s blessing to distribute billions of dollars in profits to investors via dividends and stock buybacks.

While this year’s stress tests are therefore bringing some good news to anyone owning bank stocks, investors should also take the banks’ example to heart and do a little stress-testing themselves. After all, many investors were unprepared for the scale of losses suffered by their portfolios in 2008; in some cases this proved catastrophic for their retirement planning. By taking a look at how their portfolios would behave in a hypothetical market-crash scenario – i.e., by subjecting their own portfolios to a stress test similar to the one designed by the Fed – investors can act now to make sure that their investments won’t suffer too much in a crash, or at least be prepared not to panic if they do. After all, when it comes to bank stress tests, what’s good for the goose is good for the gander.