Is your financial portfolio truly diversified? Start by understanding the correlation between asset classes
By Bernie Wolfe, founder,
Bernard Wolfe & Associates
At the start of 2008, investors believed they were getting true diversification on their stock portfolios by investing in a variety of asset classes such as commodities, bonds, and real estate investment trusts (REITs). The prevailing thought was that these other asset classes would provide some hedge against pure stock portfolios.
Then the bottom dropped out. Last year’s global financial margin call, including a general collapse in the housing market and mass deleveraging of the financial system, caused many investors to liquidate everything and anything that had a market value. The spreads of many underlying securities widened, and prices dropped across the board. Keep in mind, certain bond positions dropped significantly, even in cases where there was no exposure to troubled assets.
So we began rethinking our strategy. Traditionally, many financial planners bought in to one philosophy: Buy and hold. This strategy has typically worked for the last 80 years. Indeed, studies have shown* that if you held a fully invested stock portfolio over that time period, your returns far exceeded those of bonds, treasuries, and cash. However, there aren’t many people who have 80 years to wait for their investments to increase. And we believe our retired clients, and those nearing retirement, cannot afford to go through another 2008.
Our new motto: Row, don’t sail. Today, we are more concerned with how our clients’ portfolios will perform over the next 5 to 10 years. Indeed, there remains plenty of uncertainty given all of the recent and pending changes to our economic system. As a result, the “old school” buy-and-hold strategy may not be the safest direction moving forward. Some of the strategies we are now implementing should not be confused with market timing, for we do not believe anyone can consistently time the market — especially in this day and age.
Suggested strategies include using non-traditional asset classes, which truly have little to no correlation to traditional stock indices. While correlations among asset classes are now looked at differently, there is no denying that certain alternative investments can be a very effective hedge. There are also strategies that can produce positive returns based on sustained trends and volatility in several different traditional and non-traditional markets. While there are no guarantees, absolute return strategies are designed to provide positive returns in both good and bad markets.
The bottom line. We now want some of our strategists to have the ability to go 100% cash or stay 100% fully invested depending on the market environment. In addition, it is important to have some downside protection on stock portfolios through the use of stop orders. All of these strategies are designed to reduce the overall volatility of portfolios. Lower volatility does not necessarily mean lower returns.
To paraphrase one of our strategists, “we want to get as much of the upside while missing most of the downside.” So if the markets continue to be volatile, implementing some of these strategies should put our clients in a better position to help reach their financial goals.
*Past performance does not guarantee future results.
Questions? Contact Brad Glickman or myself for more information at 301.652.9677, and visit www.bernardwolfe.com