Financial Roller Coaster Ride

2015 so far has been the equivalent of a wild roller coaster ride in the financial markets. Up sharply, down sharply, up down, up down, and where it goes nobody knows. All of a sudden it seems that investors forgot about the continued job growth in the U.S., improving consumer sentiment, and other indicators for a better 2015. Instead the focus turned to the dollar’s increase in value against global currencies, fed policy, slow global growth and the falling oil prices……! How quickly things can change in global capital markets. What’s an investor to do in the face of all this uncertainty? As always the best strategy is not to react! We instruct our client’s to go back to the basics, which has everything to do with their financial plan. This plan acts as a financial roadmap for accomplishing your most important life goals. In your plan you should have a critically important document referred to as an Investment Policy Statement. In this statement you will want to revisit three key points: your long-term asset allocation, your loss threshold, and the long-term expected return from that asset allocation. Let’s take a few minutes to review each.

1- What is your portfolio’s asset allocation?

In other words what percentage of your portfolio is in stocks and what percentage is in bonds? If you are unable to answer this basic question it could prove to be problematic! If you don’t know your asset allocation, my suggestion is to call your broker or financial services provider and get some clarification on this important issue! What makes your asset allocation decision so important? Ultimately this one decision will drive your portfolio’s risk and volatility short term, and returns long term. And the failure to understand what things could look like in the short term can lead to very poor investor decisions that may have major long term implications!

2-What is the risk or loss threshold of your current Asset Allocation Strategy?

For any mix of stocks and bonds (your asset allocation) there is a corresponding range of what we would call standard deviation (a measure of risk). But let’s focus on what matters to you the investor. For example, if I have a balanced portfolio of 60 percent in stocks and 40 percent in bonds how much can I expect to lose? Based on historical data from Morningstar’s Ibbotson Yearbook (which tracks the history of returns of capital markets, 1926-2013) we can see that in any given year your portfolio can be down anywhere from -7 to -21 percent. So let’s look at it this way: if you have $1,000,000 invested, your portfolio could be worth anywhere between $930,000 (down 7 percent) to $790,000 (down 21 percent). This is your estimated loss threshold; and although loss is never comfortable, you should be aware of its probability and be able to tolerate it. We would strongly suggest looking at the loss threshold of your portfolio in actual dollar numbers as it gives the reality of risk more relevance. Two very important questions must follow from here, especially during volatile markets: 1- what does a -7 to -21 percent loss mean to you economically? 2- How much of this negative volatility can you experience before you sell (and ultimately lock in those losses)? The answer to the first question should have been modeled and planned for in your financial plan. As to the second question only you can answer, but it’s always better to practice the fire drill before the house is burning.

3- What is the long term expected return of your asset allocation?

The key here is expected, and again this should be spelled out in your Investment Policy Statement and modeled for in your financial plan. Having a frame of reference as to what type of return you need in order to accomplish your goals is important. It is also helpful to have this information so that you can evaluate your results from time to time (we suggest 2 times per year) against appropriate benchmarks (a standard against which the performance of an investment portfolio can be measured. Generally, broad market and market-segment stock and bond indexes are used for this purpose). We have seen many quality investment programs be compromised over the years by failing to compare results in a thoughtful way. Inevitably this leads to individual investors clamoring to take on additional risk at exactly the wrong time. Do you remember the press crying “this time it’s different” in 1999 and early 2000 before tech stocks lost 60 percent in value? Enough said!

Throughout history financial markets have never been known to run on a smooth track! We have seen this all before; what is important to remember is your asset allocation strategy has been set with two important goals in mind: to drive a return that over time will help you reach your important life goals and has a risk or loss threshold that you are aware of and can tolerate. When you are aware of the purpose of your asset allocation strategy, you can modify your behavior accordingly and resist the urge to make any short-term decisions that could have long-term consequences!

s. joseph disalvo

S. Joseph DiSalvo, ChFC, President of Quest Capital & Risk Management, LLC, has more than 15 years of experience in the financial services industry. He is passionate about helping clients build successful Financial Life Plans to align with their deeply held values and life aspirations. He founded Quest Capital & Risk Management in 1997 to create a unique business model that looks beyond a personal financial statement to help clients build their best life plan. Visit us at: