Asset allocation models are often used to give direction to investors and advisors when determining how much of an investment portfolio should be in stocks and how much should be in bonds. The classic 60/40 model is a common recommendation for an investor approaching or in retirement with a moderate tolerance for risk. We suggest you take pause and ask yourself, “Is a boilerplate allocation right for me?”
When the market is hot, how do you determine that it is too hot, and possibly time to sell and take profits? When the market is trending downward, when is the right time to buy stocks at bargain prices without fear of them going lower? These are classic examples of timing the market. Many try, but for the average investor, market timing has poor results. Rather than falling victim to unexpected market swings, allocate your holdings to accommodate your unique and individual situation. Ultimately, there will be a correction or, worse, a recession. It is just a matter of time. I will share strategies that allow you to remain invested for long term gain even when the market is flailing while protecting yourself from the negative impact of withdrawing funds for income or other financial goals when the bottom is falling out. First, let's look at three issues that could wreak havoc on a poorly allocated investment portfolio.
The market is surging in spite of global supply chain concerns. Imagine thousands of US manufacturing production lines waiting for China-made components to arrive. If a product has even one element that cannot be delivered on time, the production line could be held up or stopped altogether, resulting in missed deliveries and lost sales. It is too early to tell if supply chain disruption will be a significant factor related to the tragic spread of COVID-19 (the recently named coronavirus,) but if it were to occur, the impact on the US economy could spread faster than the virus itself.
Banks rebalance their books every night, often accessing the repo market to create the liquidity they need to maintain their operations. On September 18th of last year, a glitch occurred that the Federal Reserve did not anticipate, nor can they explain. With supply and demand out of sync, the usual boring and calm overnight Repo market saw yields jump to 10% as there were more borrowers than lenders. The interest rate jumped to five times the then normal rate of 2% to 2.25%. The Fed responded quickly by injecting billions of dollars to provide liquidity to the Repo market. Was it a glitch or a warning shot?
The Federal Reserve cut interest rates three times in 2019. These actions were in response to depressed inflation numbers and other factors that spurred the decision to reduce rates to stimulate the economy. Governments for sure benefit from low rates, but reductions are also great for companies who issue bonds (borrowing money from people just like you and me) to finance any number of projects. Companies raise capital for product development, refinancing debt at a lower rate, building new factories, new retail outlets, and the list goes on and on. But what happens if the surge in the stock market and the current success of the US economy creates a surge in inflation. The normal response of the Fed to keep inflation in check is to raise interest rates. We are living in an era of very low rates and are enjoying the growth that it is spurring. But higher interest rates resulting from a rise in inflation could be like an ice-cold Gatorade bath over the head of our economy that could leave the markets gasping for air.
Look at your investments. Know what you own. Understand the importance of balancing your investments with your ability to endure a correction or, worse, a recession. The first step is to look at your investments as they relate to your financial goals, how much time you have between now and the day/year that you expect to access the money. This is called your “time horizon.” If you are like most people, you will have multiple financial goals and multiple time horizons. For example, the time horizon for investments in a college education fund for a fifteen-year-old is about three years while retirement could twenty or more years away. The money you will need for income in retirement has a different time horizon than the money you expect to leave to your heirs (depending on your age, of course.) If your financial advisor is not talking to you about the allocation of your investments and how you would fare during and after a market downturn, you could find yourself unprepared. Using leading financial planning software and years of financial planning experience, we can help you project the impact of a 2007-2008-like event, and your probability of meeting your short and long term financial needs, wants, and wishes. Then, we can help you update your allocation to maximize your probability of success, giving you the peace of mind that you need to breeze through the next market downturn.
Boilerplate allocation percentages such as 60% stock and 40% bonds might not be right for you. Segmenting your assets to fit your goals and the time horizon for each is essential. Allocating your investments to the asset classes and financial products appropriate for each financial goal (and time horizon) will help you sleep at night even when the storm clouds are rumbling.
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Roger Walker is a financial advisor, planner, author, and founder of Walker Wealth Management, LLC.
Office: (731) 434-4139