Printer Friendly

Money Management: Time to protect your portfolio: applying the lessons from the Great Recession.

Byline: Daily Record Staff

This has been a roller coaster year in the markets. As of Nov. 20, the S&P 500 was on the verge of its second 10% correction for the year (source: Yardeni Research, Inc. Nov. 16, 2018). Not surprisingly, 67% of asset classes had negative returns as of Oct. 31 a number last seen in 2008 and 2011 (source: BofA Merrill Lynch.). In some ways, the last two months have felt like the 14th round in a heavyweight prize fight: Everybody is getting beat up.

In contrast, the Conference Board Leading Economic Index increased through September 2018 with a projection of 3.5% growth in the U.S. economy for the second half of 2018 and indications that the economy is healthy (source: Conference Board Leading Economic Index: "Economy Will Continue Expanding Through 2018" by Jill Mislinski, Oct. 18, 2018).

If the economy is relatively healthy, is the market trying to tell us something?

Yes. The market is saying, "Wake up, remember the lessons from 2008, and apply them."

From 2016 to mid-January 2018, the S&P 500 had a pretty long run without a 10% correction. In 2017, over 90% of assets classes had positive returns (source: BofA Merrill Lynch). Similarly, from 2005 through September 2007, the S&P 500 did not have a correction of 10% (source: Yardeni Research, Inc., Nov. 16, 2018). In 2006, over 90% of asset classes had positive returns (source: BofA Merrill Lynch). At the end of 2007, volatility returned and the S&P 500 lost 56.8% of its value from October 2007 to March 2009.

Now, we don't know if 2017's performance and 2018's volatility are indicators of a brooding bear market. It is a fool's mission to make stock market predictions. We do know that we are even more foolish if we do not learn from the Great Recession. So, let's review the lessons learned in 2008.

Understand your risk capacity. Risk tolerance is generally the risk that an investor is comfortable taking. Risk capacity measures the risk you need to take to meet your goals. When your risk capacity is not aligned with your risk tolerance, you may face a shortfall in meeting your goals because you were: (a) too conservative (low risk tolerance relative to higher capacity) or (b) too aggressive (high risk tolerance, but lower capacity). The key here is to confirm that your asset allocation and investment plan are aligned with your risk tolerance, risk capacity and your goals. Generally, don't take more risk than necessary to meet your goals.

Diversification works. Most investors should have a portfolio that is diversified in asset class (stocks, bonds, alternatives, REITs), size (large cap, mid cap and small cap), style, sectors and by country. A diversified portfolio with broad exposure to different markets and assets should smooth out volatility and limit capital risk. Without a diversified portfolio, you are testing fate in a bear market.

Fixed income is crucial. Fixed income doesn't always capture the headlines. However, an allocation to lower correlation, less volatile, safer fixed income assets in your portfolio is critical. Your fixed income allocation should add capital risk protection and contribute to total return. If you reached for income and have taken on a larger position in High Yield bonds (or are using dividend paying stocks/REITS as proxies for bonds), you may be taking equity like risk rather than AA/AAA rated fixed income risk. Proper, active, fixed income management is essential to navigating a bear market.

Beware of behavioral bias. There is plenty of evidence (including Nobel prize-winning research) showing that humans are not particularly equipped to be long-term investors. Essentially, our survival biases interfere with long-term investing. For example, recency (the most recent events are freshest in our minds and cause us to expect similar results), overconfidence and loss aversion are incredibly difficult biases to overcome.

If losing a dollar hurts more than gaining a dollar, you have felt loss aversion. This is crucial when there is a market decline. A properly diversified portfolio that is meeting your goals should be able to work through a bear market. If you make investment decisions because of recency, overconfidence and loss aversion, you are likely to capture losses rather than letting the portfolio do its job.

Think of people who sold at the bottom of 2009. If you recognize that these biases have hurt you in the past, consider using a professional money manager. They will earn their fees by managing your portfolio with a disciplined process built to avoid these biases.

One last lesson from 2008 is to remember that even though a -56.8% bear market may be unlikely, it is not impossible. Now is the time to review these critical lessons and take the steps necessary to protect your portfolio.

George D. Marron, JD, CFP is vice president for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, businesses, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534, (585) 586-4680.

Copyright {c} 2018 BridgeTower Media. All Rights Reserved.
COPYRIGHT 2018 BridgeTower Media Holding Company, LLC
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 2018 Gale, Cengage Learning. All rights reserved.

Article Details
Printer friendly Cite/link Email Feedback
Publication:Daily Record (Rochester, NY)
Date:Nov 27, 2018
Previous Article:Danielle Ponder takes it to the stage.
Next Article:Woods Oviatt Gilman planning move to Legacy Tower.

Terms of use | Privacy policy | Copyright © 2021 Farlex, Inc. | Feedback | For webmasters |