Does Your Investment Portfolio Have Shock Absorbers?

By R. J. Kelly, CAP, ChFC, CEPA, CLU, MSFS, RICP, IAR, AEP | Wealth Legacy Group®, Inc. | San Diego, CA 

Did you know 2017 was the calmest year for the financial markets in more than five decades?  But times have certainly changed.  Through June 25, 2018, the S&P 500 Index has had a change in closing price of at least 1% on thirty-six days.  By comparison, in 2017, there were only eight days when the S&P 500 moved at least 1%.  Not only that, but the S&P 500 has changed at least 2% on eight days already this year.  2017 did not have a single day when the S&P 500 moved 2% or more.  The markets are now on pace for the most volatile year since the market crash of 2008 when we experienced the subprime mortgage crisis.

If we were facing serious economic challenges — something that might be signaling a recession — it would be a cause for concern.  For right now, we are not in such a situation, but let’s put a “fence at the top of the cliff.”  Having a fence at the top of the cliff will protect your investment portfolio, regardless of how many ups and downs occur in the financial markets . . . “Imagine That™”!

Are You Prepared if the Financial Markets Take a Nosedive Next Year?

I am hearing and reading from a number of sources the possibility of the financial markets taking a nosedive as early as next year.  These are all just prognostications and they could very well be incorrect.  But sooner or later, they will come true — just as we saw in the three down years of 2000-2002 and of course, in 2008.  Have you prepared to protect the principal value of your financial investments from a market drop?  What if you are nearing retirement — or are in retirement?  How can you — are you — protecting your principal from a sudden drop in the market?

It’s important to understand that losses affect your investment portfolio more than gains do.

Here are a few examples of how devastating losses can be:

     Portfolio Loss                                        Gain Needed to Just Get Back to Even

               20%                                                                                   25%

               30%                                                                                   43%

               40%                                                                                   67%

               50%                                                                                   100%

Investment Funds with Protection Against Large Losses of Principal

There are several ways to provide some “shock absorber” protection to your investments.  You could, for example, liquidate all your investments and keep everything in cash.  This would obviously not be a great idea because of inflation risk — the cost of living continues to go up and your cash will decrease in buying power.

Due to the increased volatility in the stock market since February, more of our clients are looking for allocations which protect against large losses of principal.  For example, one platform we use protects client’s equity positions by having an automatic stop-loss cap.  If the target index drops by a certain percentage from its highest value, the equities are liquidated and moved into more traditionally stable holdings like bonds.  The more conservative allocation remains in place until a buy signal is triggered once the market stabilizes.  It is a cost-efficient way to capture gains in the equity market, while automatically protecting your portfolio from significant market losses.

Diversified/Non-correlated assets

Another way to provide protection is to have diversified and “non-correlated assets” in your investment portfolio.  A lack of diversification is often the result of missing certain “asset classes” or having certain asset classes overweighted or underweighted in your investment portfolio.  While there is some disagreement as to what exactly an asset class is (for example, intellectual property — including patents, trademarks, and copyrights — has been listed as an asset class in one portfolio seen), I would suggest there are five primary categories into which most of your money should be invested.

The five primary types of investment classes are:

  • Cash and its equivalent — treasury bills, notes, money market funds, or FDIC insured bank deposit, including a new option providing FDIC protection up to $2.5M per person
  • Fixed income investments — fixed annuities, high grade government, corporate or municipal bonds, with a rather new concept that adjusts upwards as interest rates increase
  • Ownership in publicly-traded businesses — domestic and international stocks in outright ownership or through indexes or exchange-traded funds (ETFs)
  • Real estate — apartments, offices, storage units, industrial warehouses, by direct ownership or indirect ownership through real estate investment trusts (REITs), syndications, partnerships, etc.
  • Commodities — productive farm land, oil, minerals, timber, water rights, mines, precious metals, such as gold, platinum, etc.

Each asset class has its own benefits and drawbacks.  The specific asset allocation of your portfolio will depend on several factors, including your “risk tolerance,” timelines, needs, and resources.

One of our favorite platforms not only provides a fully diversified basket of funds to have full market exposure, but they also include funds designed to generate returns insulated from stock or bond performance.  You can reduce the overall risk in an investment portfolio by utilizing several different non-correlated investment options like this.  The amount of correlation to the stock market, for example, can be measured, ranging from -100% to 100% and is based upon historical returns.  A correlation of -50% tells you that 50% of the time they were moving in opposite directions — one stock or asset class was going up while the other was going down.

By mixing non-correlated assets into your portfolio, you are better prepared to “survive” the fluctuations in the market and the ups and downs in your overall portfolio values.  Holding only one asset class brings the greatest volatility, and often a lower return over time.  Mixing in other asset classes, with the differing lengths of “financial cycles,” will reduce the degree of volatility, improve returns over time … and help you sleep better at night!

Conclusion — Add Some Shock Absorber Protection

Since February, the U.S. stock market has been experiencing a great deal of volatility.  How are you doing with that?  How about adding some “shock absorbers” to your portfolio?  Let’s sit down and review your present holdings and situation.  We can give you a second opinion on how to structure your portfolio to defend against market volatility — and the inevitable market correction that is coming.  It is possible to be invested in the stock market AND have peace of mind … 

“Imagine That™”!

Written by R. J. Kelly – June 2018

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