On everyone’s mind right now is the volatility in the stock market.
The key to maintain your sanity is having a balanced investment portfolio based on your own risk tolerance. Balance is the combination of fixed income, equity and cash in general terms. We can drill down to specific types of fixed income and equities as well. The use of alternative investments including annuities, real estate, private equity and other investment can provide a real hedge to create negative correlation to the stock market. This means that your portfolio would not perform in tandem with the market performance and create more stability of returns and risk.
We must keep a long- term perspective on investing. Let’s examine the recovery data from stock market declines since 1945.
The Deeper the Stock Market Decline, the Longer the Recovery (Declines in the S&P 500 index since 12-31-1945)
S&P 500 Price Declines (December 1945 Through July 2016)
|
Number
|
Average Drop From Peak (%)
|
Duration (Months)
|
Time to Recovery (Months)
|
Type of Decline
|
Pullback (5.0–9.9%)
|
56
|
-7
|
1
|
2
|
Correction (10.0%–19.9%)
|
21
|
-14
|
5
|
4
|
Bear Market (>20%)
|
12
|
-33
|
14
|
25
|
(20%–39.9%)
|
9
|
-26
|
11
|
14
|
(>40%)
|
3
|
-51
|
23
|
58
|
Source: CFRA and S&P Dow Jones Indices.
|
As you can review, for all market downturns that experienced a pullback or correction, the recovery time was extremely quick. Even bear markets up to minus 39.9% recovered within one and one-half years.
This assumes that your portfolio is completely invested in the S& P 500 index which is probably not the case.
I hope this chart helps to ease your mind in terms of the noise and news coverage.
The key is to make sure that the risk component of your portfolio is in line with your specific risk tolerance. Most advisors have access to some type of risk assessment software illustrating what happens in a down market or to share historical performance during different time periods of negative performance.
Portfolio construction is paramount in terms of market exposures for both equities and fixed income.
What are some options to help protect your portfolio from some downside risk?
Adding alternative investments are those that do not fit into the standard equity or fixed income classifications. These investments typically offer additional attributes in their investment profiles such as low or non- correlation or other facets that help move the overall portfolio down the risk spectrum. The inclusion of these alternative investments maybe worth considering in a more balanced portfolio as a means of potentially lowering overall portfolio volatility. Alternative asset classes consist of, but are not limited to, managed futures, long short funds, multialternative, market neutral, global macro funds, merger arbitrage and other hedged type funds.
You may be able to protect some downside risk but also please remember that you will not participate in the full market performance on the upside. This is one the trade-off of adding alternative investment options.
These investments are not suitable for everyone involve special risks, such as risk associated with leveraging the investment, utilizing complex financial derivatives, adverse market forces, regulatory and tax code changes and illiquidity. There is no assurance that the investment objectives will be attained.
I am not making any specific recommendations. This is strictly educational information. Please discuss with your advisor whether you should add alternative investments to your portfolio.
Let’s take a look at how some of these strategies work:
Market Neutral funds: This type of fund includes covered call writing and convertible arbitrage and are intended to provide fund with enhanced potential for risk managed returns due to dampen volatility. The downside of this investment includes high risk due to their investment strategies relying on the use of leverage, short selling and arbitrage to achieve the desired outcomes. This type of fund typically has low correlation to the fixed income markets.
Long/Short funds: This type of fund seeks risk adjusted and absolute returns across the global equity universe. It utilizes a global long/short strategy to invest in publicly listed equity securities. The downside of this investment includes high risks due to alternative investing techniques such as leverage, derivatives and short positions. They often have higher fees and have less liquidity than standard mutual funds.
Other alternative investments include but are not limited to:
Real Estate Investment Trust (REIT): This type of non-traded real estate investment is an option because it provides less correlation to the stock market and can provide monthly income from regular distributions. They are generally illiquid securities for which no public market exists. As such, investors may be unable to liquidate the security at any price. Real estate investments are subject to a high degree of risk because of general economic or local market conditions; changes in supply and demand; competing properties in the area; changes in interest rates; and changes in tax, real estate, environmental or zoning laws and regulations. Real estate units/shares fluctuate in value and may be redeemed for more or less than the original amount invested. There is no assurance that the investment objectives will be attained.
Annuities: This type of investment can offer a role to reduce market volatility due to the contractual guarantees. The guarantees are based on the claims paying ability of the issuer. Due to the vast offering in the marketplace, it is imperative you identify what is important to you and then search for an annuity that meets your criteria.
Annuities are long term, tax deferred investment vehicles designed for retirement purposes.
How will your portfolio react should we experience another 2008-9? There are ways to back-test your portfolio to examine what happens should the market suffer large losses again. Understanding the actual risk on your money is just as important as the return on your money.
It is also key to grow your money to combat future inflation and taxes. Future health care cost will be the most pressing issue.
Now is a great time to review your portfolio to make sure you are doing everything that makes sense to provide a successful financial future.
This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product.
Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met.