With the market volatility over the past 3 months, some investors are asking, "Should I be changing my investments?
There is no one-size-fits answer, but some tweaks might make sense.
Disciplined investors create a diversified portfolio of investments that are not all directly correlated to each other. Wise investors take this one step further and adjust their portfolios as market cycles shift. A consistent buy-and-hold strategy might be far more risky than one that involves tactical shifts according to the season.
Take most 13-year-old boys who love wearing shorts and T-shirts. They love this so much that they wear this attire all year-round, no matter how cold it is outside. Boys do this for two reasons:
It's the style now.
They are 13 - and just don’t know any better.
This is not unlike how a lot of individual investors behave. They follow a traditional asset allocation with a buy and hold approach, regardless of what the market is doing. This works fine in a bull market, just like wearing shorts and a T-shirt is fine during the summer. But it gets you crushed in a down market.
Think about three different types of markets, each requiring its own investment strategy:
So-easy-a-caveman-could-do-it market
In such bullish times, the market goes up in a mostly straight line. Even someone with a brain the size of a walnut could make 15% per year.(apologies to any cavemen reading this, if you can read - that is).
The 1995-1999 tech-boom market is a great example as was the most recent 11-year bull market. In these types of markets, just about anything that you invested in worked very well. This is typically true regardless of any investment strategy.
Bear market
This is a period where the market is down a lot. Great examples are the 2000-2002 and 2008 markets and maybe the 2020 Coronavirus bear market happening now. Any strategy that has you fully invested gets hurt in this type of market. This is just like a 13 year-old wearing shorts in the dead of winter: he feels comfortable because everyone is doing it, but he is freezing his butt off. In this market environment, a better strategy might be to invest more defensively.
Risky market
A risky market is one with high volatility which produces some returns but is at great risk of falling back into a slump. The current cycle kind of embodies this.
Yes, the market entered into a bear market, but volatility is also at its peak. We have seen historical one-day point losses and one-day point gains this year.
Although a fully invested strategy in this market could work out ok, is the risk worth it? That depends on your appetite for risk of course.
This is like that 13-year old boy wearing shorts in the fall: If he gets a warm day, he is fine; if he doesn’t, he gets really cold. Maybe a more modified approach is the way to go in this market.
Tactical investing
A good tactical strategy may trail a fully invested approach if the market is going up in the face of great risk (albeit with much less volatility). But it can protect you if the risky market turns bearish. With this strategy, the mix of assets are altered based on their price performance, and certain asset classes are favored based on current market conditions.
For example:
During recessions Large-Cap companies tend to withstand better than small companies. Small companies often don't have the size and scale to withstand as well during long periods of low sales. However in the long-term small companies as a whole outperform their large-cap counterparts.
Bond prices fluctuate based on their sensitivity to interest rates as measured by the bond's duration. Long-term bonds are more sensitive than short-term bonds, and bond prices and the direction of interest rates have an inverse relationship. Therefore when rates rise, bond prices go down and vice-versa.
Other considerations are Domestic vs. International exposure, Value vs. Growth, Bond type/quality (corporate, high-yield, government, etc.) and Sector selection
These are just some examples of the deeper decisions that go into the security selection of a portfolio. This is not a market timing strategy which involves predictions of moving in and out-of-the market. Rather we use a modified strategic asset allocation strategy with quarterly tilts which drills down further - seeking to uncover better risk/return opportunities based on current market conditions vs holding broader asset classes through all market cycles.
In the past, portfolio changes required expensive trading costs as commission were generated every time investments were bought and sold. The benefits often didn't outweigh the costs. The custodian that we use at Weiser Financial Planning does not charge any commissions on stocks and ETF trades so we can avoid the typical transaction costs that would inhibit this strategy.
Please reach out for additional information on our investment philosophy and to discuss your account as I'm happy to help answer any questions that you may have.
