Play Defense with a Solid Portfolio

The pictures and stories from Japan have shocked us all. The human aspect of this country’s struggle to cope with the earthquake and tsunami tugs at our hearts. The same applies to those in Middle Eastern countries crying out for freedom and democracy only to be responded to with bullets and bombs. While the human factor is not to be taken lightly, the economic consequences are making the most headlines. These headlines helped to bring back some market volatility that reminded me somewhat of 2008. The markets pulled back and rebounded from the news in Japan, Egypt and Libya relatively quickly. However, the indicators that track investor confidence tell us that investors are becoming more nervous about the future.

What is the individual investor to do in these volatile times? I would urge you to do nothing IF your portfolio is properly allocated. Why? Investors tend to do poorly when they react to what the market does instead of preparing for what has historically happened over the many years of market history.

Reactionary behavior creates poor performance, thus bad investments. Data from Morningstar indicates that investors tend to buy investments high and then sell investments low. We see this through inflows and outflows in the stock market. The largest inflows come at historical market peaks while the largest outflows come at historical market bottoms. To make matters worse, those outflows from stocks flow into bonds, which are at their historical highs. This seems like a simple, commonsense problem, but each time extraordinary events happen in the stock market, people will ultimately say, “This time it’s different.”

John Templeton, a mutual fund pioneer and asset manager said, “The most dangerous words in investing are ‘This time is different.’”

Going forward into the unknown, investors will make money by creating a wise investment strategy and sticking to it. Good investment strategies may still have time periods where performance lags in times of crisis. For example, during the rise of the tech bubble at the end of the 90s, a good investment strategy lagged the performance of the tech stocks people were using to get rich. However, the good investment strategy didn’t crash like many of the tech stocks. What is a wise investment strategy? When investing, you want to maintain a diversified portfolio, keep cost low and always invest for the long term. Do this by choosing an asset allocation of stocks, bonds and commodities that matches your age and or objectives. Be wary of stockbrokers; they are there to make a sale, not provide advice for individual needs. People in this line of work usually talk fast and may make you feel good, but in the end, you are the one stuck with paying a Cadillac price for a Chevy Nova. Choose index funds over mutual funds. Finally, when the market becomes volatile, stick to your allocation.

There are many free resources to help an investor choose a proper allocation by age or risk tolerance. Morningstar, S&P and Down Jones all have their own allocations that are available on the web.  If you are 15 years away from retirement and a moderate risk taker your portfolio can look something like the following.

 

Sample Moderate Risk Portfolio

 

BONDS 45%

 

US Aggregate Bond Index

20%

Treasury Inflation Bonds

5%

Developed Foreign Treasury Bonds

3%

US Corporate High Yield Bonds

5%

Short Duration US Corporate Bonds

5%

Emerging Market Bonds

7%

STOCK 50%

 

S&P 500 (Large Cap US Stocks)

15%

S&P 400 (Mid Cap US Stocks)

10%

S&P 600 (Small Cap US Stocks)

8%

Developed International Stock

12%

Emerging Market Stock

5%

COMMODITIES (Diversified)

5%

A Person approaching retirement or looking for more income growth opportunities can adjust the allocations above and include investments focused on dividends. Wiser Wealth Management uses a model similar to the one below.

Sample Moderate Risk Portfolio

 

CASH  7%

 

BONDS  60%

 

US Aggregate Bond Index

28%

Short Duration US Corporate Bond

3%

US Corporate High Yield Bonds

8%

Developed Foreign Treasury Bonds

3%

Emerging Market Bonds

8%

Short Duration Treasury Inflation Bonds

10%

STOCKS 30%

 

S&P 500 Dividend Stocks

8%

US Preferred Stock

4%

S&P 400 (Mid Cap US Stock)

4%

S&P 600 (Small Cap US Stock)

3%

International Dividend Paying Stock

8%

Emerging Market Stock

3%

COMMODITIES (Diversified)

3%

Current 12 Month Portfolio Yield 3.9% One Key difference between the most successful investors and everyone else is the ability to do the opposite of your instincts. Look at your portfolio and pick an allocation for today, meaning do not look at the past portfolio performance but simply focus on where you need to be in relation to risk going forward. You cannot change the past, but you can change how your portfolio reacts to major down swings in the future.  When the next correction happens, ignore that temptation to move to cash and stick with you portfolio that has been built to weather the storm.

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