Money Matters

Impact PartnersVoice: Four Benefits Of An Efficient Portfolio

(Source: www.forbes.com)

Recently, the Dow Jones eclipsed 26,000 points. In response to this news, many people asked, “How long will the market continue to climb?” Some are predicting the Dow will climb to 30,000 before the market slows down, while others caution that this is an overvalued market and cannot be trusted.

The average investor is left wondering whom to believe: “Should I be changing what I’m doing with my investments?”

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Last week, I met with a couple who have these questions as they prepare to retire in less than a year. They realize they need growth in their portfolio to be able to keep pace with inflation over time but are afraid of losing retirement savings.

They told me their investments were conservative, but they lost over 35% in the 2008 market correction. “We were always told that our asset allocation model would protect us from a major decline because we were diversified,” they said.

Perhaps you’ve been told these things and experienced a similar outcome. A student in one of my retirement classes in 2009 spoke up, saying, “All asset allocation did for me was spread the pain around in a whole lot of places.”

Although asset allocation should be a focal point in your portfolio, it does not guarantee efficiency. So what exactly is an efficient portfolio, and why is it important to your financial success?

For your portfolio to be efficient, the average rate of return should be greater than the standard deviation. If your 10-year average rate of return is 7%, your standard deviation (risk) should be less than 7%. In most portfolio analyses we conduct, the standard deviation is much greater than the average return, which can cause big swings in returns, both positive and negative. We call this portfolio “wobble.”

Having less “wobble” in your portfolio can have great benefits:

  1. You can have more consistent returns.

The stock market can be up and down like a roller coaster. Your emotions often go up and down along with those returns. It is certainly fine to have a “play” account that allows you to seek short-term thrills, but the investments that you’re counting on for a lifetime should be more consistent.

  1. Your average returns will be more accurate.

If you experience a big decline, your average return will never be your actual return. If you invest $100,000 and experience a 50% return in the first year, you now have $150,000. If you have a 50% loss in year two, you have $75,000 remaining. Your two-year average return is 0%, but the actual return is -25%. Average returns can be very deceiving.

  1. It can help you stay true to your goals.

I recently met with a family who reluctantly told me they have had over $500,000 sitting in a money market account since December of 2008. “We were losing so much money, so fast, and didn’t know what else to do,” they told me. “We realize now that we should have sought help much sooner, but we were just afraid of the stock market.”

Many of you reading this can identify with this couple. Others may have just stayed the course and waited for recovery. Although your portfolio did eventually recover, it wasn’t efficient. Fear and greed are the two emotions that can hinder our long-term goals — an efficient portfolio can help protect from both.

  1. It can reduce your exposure to volatility.

My wife, Kristin, and I were on our way to Las Vegas for an industry meeting. We spoke to a couple sitting behind us who were traveling from Houston, where we made our connecting flight. Kristin asked if they were traveling for business or pleasure, and the husband laughed and said, “I’m going to make my annual donation to Vegas.”

He accepted the fact that, by gambling, he would more than likely lose money.  Many investors in the stock market simply accept that their portfolio will eventually suffer a significant loss due to a market downturn. Although there will always be fluctuation in the value of our equity investments, we should not be satisfied with losses of 25% or greater.

There are several investment philosophies that advisors use to guide investors; more on these in my next article, but I will provide a short synopsis here.

“Buy-and-hold” is exactly as it sounds: You purchase your investments and let them ride the markets. Rebalancing is similar to buy-and-hold, but you periodically rebalance to your original percentages in each allocation.

Momentum investing looks at 15 global asset classes and rebalances monthly to the nine best–performing asset classes over the past six months. There are contracts available that allow you to participate in this strategy with a floor of zero.

Tactical wealth management uses the Recession Probability Index to measure the potential impact of 26 sectors of economic data that can affect the markets. Every 30 days, this data is used to determine the appropriate weighting of each allocation in the portfolio. The tactical approach, as well as momentum investing, can help provide more consistency to your overall portfolio.

Although each investment model has an area where it can excel above another, you should not overlook the benefits of a consistent, efficient portfolio.

Investment Advisory Services offered through Retirement Wealth Advisors (RWA), a Registered Investment Advisor. Legacy Retirement Group, LLC and RWA are not affiliated.

More Info: www.forbes.com

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