Oct 31, 2014
“When feeling seasick…” – Part 2
We recognize that today seems like a particularly uncertain time. Ultimately, every client’s needs are unique, and we work hard to develop the portfolio that is right for each personal risk tolerance and situation.
As we prepare our clients for more potential volatility in their portfolios, there is a distinct process we employ depending on a client’s age, time frame, and investment objectives. It is rather ingrained in most investors’ minds to avoid straying from their investment plan, but we believe the simple answer of “do nothing” is also inappropriate.
Assess our client’s progress. Stocks have produced outsized returns for those who held or expanded their equity positions in late 2008 or early 2009. Perhaps we can afford to lower the portfolio’s current risk profile a bit without undermining the client’s long-term goals. Prime candidates are those investments that have shown the strongest gains. It’s not an all-or-nothing decision; even modest repositioning can make a quantitative and psychological difference in a significant downturn.
Revisit our overall diversification. There are market sectors that haven’t shot the lights out and display relatively low correlation to stocks. They may not be less risky in the near term, but their risk-reward equation may be more favorable. Reviewing diversification is reassessing that we still own “eggs in many baskets,” rather than searching for a single best investment or the next “hot” stock.
Respect cash and (some) bonds. There’s practically zero yield these days on “cash equivalents” such as money market funds and short-term CDs. For those investors relying on their portfolio for income, we ensure there is at least 1-3 years of income payments in short-term investments, such as cash and short-maturity bonds. While this portion of the allocation does not generate a lot of return, it certainly provides peace of mind that next month’s income payment does not need to come from stocks.
We aren’t afraid of being a little bit wrong. What’s so bad about reducing one’s risk even if the market does quickly return to its uptrend? This isn’t about bragging rights or the ability to predict market moves. It’s about measuring and managing clients’ risk from a position of strength and equanimity rather than fear and loathing.
Embrace the down market. For long-term investors, market downturns can be welcome events, and the ability to act rationally and timely can be very rewarding. Historically, in the early stages of bull markets, about 70% of the return comes in 50% of the time. The S&P 500 bottomed on March 9, 2009, then gained more than 37% in just the next two months. Missing that initial spurt would have knocked the cumulative bull-market gain through August from approximately 230% to 140% (Source: Toews Corporation).
Nobody relishes the prospect of a bear market or correction. The trick is to accept its inevitability and treat it as just another phase in a disciplined, long-term strategy.
When you read another headline about uncertainty in the world today, try to stay focused on the horizon, as our team does each and every day.