Markets

Does Your Investment Portfolio Have Emergency Air Bags Installed?

This safety measure is one every investor needs in times of extreme stock market turbulence (like right now), and it requires the right kind of active management.

Between the late-February market sell-off due to Coronavirus fears and the record highs achieved in January, I’ve spent a lot of time this year fielding questions from clients about whether it might be time to pull out of the markets. Surprising, right? But both rise in performance and a drop in performance can spark the same kinds of concerns.

The concept of selling in these situations can be summed up as the “up a lot” and “down a lot” styles of investing: Markets are “up a lot” so we should get out before they fall, or markets are “down a lot” so it must be time to get out before it gets worse.

That might sound sensible in general terms, but try to imagine what it would be like to manage a portfolio like this. What does “a lot” actually mean? Which asset classes would make for a “safer” alternative? How much do you sell, and why? In my view, the “down a lot” approach is even more threatening to your financial security: It’s like thinking you might be at risk of an accident and knowing your car has air bags, but deciding to jump out anyway.

These strategies are, in my opinion, a dangerous take on active management. But there is an alternative.

What makes for good active management?

I’m a supporter of active management as a means of mitigating risk and uncovering opportunities. But as I tell my clients, active management is very different from trying to time the market based on past performance or a gut feeling, like the “up a lot” or “down a lot” philosophies.

Rather than making decisions solely on markets rising and falling, I think it’s important to look at how the underlying economic picture is developing. Looking at a broad range of economic indicators can provide a more nuanced view of the economy and where things might be heading.

One of the active managers I turn to for my clients’ portfolios does exactly that: the portfolio managers keep track of about 20 different indicators touching every aspect of the economy, from consumer behavior to geopolitical risk and business outlook. Taken together, these analyses provide a tapestry of information. This can be assessed as a whole to help provide a picture of the potential risks facing the markets.

Using that information, portfolios can be adjusted to mitigate the impact of growing risk in the economy and to potentially help avoid the impact of severe market downturns.

How does that look for clients – and what’s the difference?

In my opinion, this is a significantly different approach compared to the way most portfolios are managed.

Most active investment managers will create a core asset allocation and perhaps include a “risk budget,” or some limits to the amount of volatility allowed in the portfolio. A manager might incorporate some economic indicators into this strategy and have a process for tactical decision-making. However, that’s where most of them will stop. Instead, good advisers will take an important additional step: personalized/customer risk management.

What does that look like? At my firm, we track the level of volatility that is personalized to the client’s asset allocation. If we see volatility outside what we would consider “normal” and believe this it is not a short-term correction, we will look to reduce risk in the portfolio by selling off assets, starting with the riskiest ones first. What many of my clients fear above all is another 2008. Taking these kinds of non-normal events (aka black swan events) into account and factoring in an investor’s specific individual needs means that we can seek to better control volatility through any market cycle.

Combined with the broad economic projections we talked about above, this is the next level of active management, one that is both highly tailored to the individual (pinpointing their own risk threshold) and highly attuned to the possible directions of the economy at the same time.

These are the air bags in your portfolio, and when they’re deployed they can help to cushion the blow of an economic turn for the worst.

Engineering versus emotion

Designing a portfolio that works like this is a lot like building a car: It takes engineering, not emotion. The process relies on having the discipline to spot big risks and build a portfolio that can deploy the air bags at the right moment. When that air bag is deployed, you start taking steps to move from riskier assets to more conservative assets, and even toward cash if the road starts to look very treacherous.

This is so important. It’s very easy to get caught up in the latest news about a single economic indicator or a single geopolitical headline, including the Coronavirus. It’s hard not to fall into it: The news is loud, and it tends to focus on one big story at a time. The unknown is always the scariest.

But the economy is far more complicated than headlines, and it’s important to have a process in place for analyzing it — and reacting to it.

On the other hand, a lot of advisers will invest your money in a long-only model portfolio that won’t adjust when the market turns — and more importantly won’t increase the cash allocation if they are forecasting a recession. Even if they’re nervous, these advisers are unlikely to make any changes to help preserve your savings; you’ll just have to grin and bear whatever the market brings. I think this is also a mistake.

For me, the key is to be responsive to the market without getting emotional. Rather than relying on rules of thumb, build a strategy that can give you all the benefits of well-designed and well-engineered risk management.

For more information on this modern, personalized approach to risk investment management, click here for a more detailed article about my approach.

About the Author

Bradford M. Pine

Wealth Adviser, Bradford Pine Wealth Group

Brad Pine is a wealth adviser and president of Bradford Pine Wealth Group, based in Garden City, N.Y. BP Wealth Group assists individuals and entrepreneurs to create wealth, simplify their lives and plan for retirement. Honesty, integrity and reliability are the foundations of Pine's investment philosophy.

Most Popular

Senate Passes $3,000 Child Tax Credit for 2021
Coronavirus and Your Money

Senate Passes $3,000 Child Tax Credit for 2021

The provision would temporarily increase the child tax credit to $3,000 or $3,600 per child for most families and have 50% of it paid in advance by th…
March 6, 2021
Senate Passes Bill with More "Targeted" Stimulus Payments
Coronavirus and Your Money

Senate Passes Bill with More "Targeted" Stimulus Payments

The Senate finally passes the $1.9 trillion COVID-relief bill. But fewer people will get a third stimulus check under the Senate version than under th…
March 6, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

Are You Going to Run Out of Money in Retirement?
retirement planning

Are You Going to Run Out of Money in Retirement?

A portfolio stress test can help give you some peace of mind about that … but if you’re not careful, it could give you a false sense of security. To g…
March 8, 2021
The Cost of Retirement Has Tripled! But a New Way of Planning Can Help
retirement planning

The Cost of Retirement Has Tripled! But a New Way of Planning Can Help

With today’s low interest rates and paltry dividends, the old way of saving for your retirement and living off your dividends and income to preserve y…
March 5, 2021
The Basics of Required Minimum Distributions: 12 Things You Must Know About RMDs
Financial Planning

The Basics of Required Minimum Distributions: 12 Things You Must Know About RMDs

Retirement savers who are 72 must start withdrawing funds from tax-advantaged retirement accounts. Here’s what you need to know about required minimum…
March 4, 2021
A COVID Storm Hits Senior Living
Coronavirus and Your Money

A COVID Storm Hits Senior Living

The pandemic has created significant challenges for all types of senior living communities. Because of that, it's more important than ever to review a…
March 3, 2021