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Should I invest now?

I’ve been getting this question a lot this summer: “Should I invest in the market now, or is this the top of the market?”

Here’s my response:

If you watch the news, there’s always a reason not to invest. Think back to the election and the fiscal cliff.  Who would be crazy enough to invest at the end of 2012 when the fiscal cliff was right in front of us?  Then again, The market has gone up and up this whole year with only a few speed bumps.

If you run the numbers, the research suggests that you’re better off moving the money into the markets despite what you hear from the media. Don’t try to time when to buy or sell. But that may be too hard to stomach for many investors.

And then there is the middle ground – invest in the markets on a regular basis over a certain period of time – called dollar cost averaging.  Instead of investing 100% of your portfolio right away, you could invest 25% of it for four months.  That may reduce the risk of buying a security only to see it drop shortly after you purchase it. This allows you to ease back into the markets, instead of jumping in.  Keep in mind, this method does not ensure a profit and does not protect against loss in a declining market, so investors should consider their willingness to continue purchases during a declining or fluctuating market.

Top takeaways from 10 articles on asset allocation.

I’ve been doing a lot of reading on Asset Allocation this morning and here are a few key takeaways that I think might be helpful to investors:

  • Static allocations assume the relationships between the various asset classes stay the same.  Dynamic allocations assume that the relationships are constantly changing.  Look back over the past five years and you can see how the relationships are in constant state of fluctuation.
  • Dynamic asset allocation can be accomplished with frequent reviews, opportunistic components, and flexible strategies.  It’s more active than static, and requires more effort and time.
  • Leveraging a portfolio (borrowing money to buy more of a certain asset class) to create risk parity across each asset class can reduce the overall risk of the portfolio while providing acceptable returns. This can be complicated to do on your own and comes with its own set of risks and higher costs (cost to borrow money).
  • Marcus Schlumerich, author of The Efficient Frontier in Modern Portfolio Theory, got it right when he stated that “a portfolio is efficient if no other portfolio has the same expected return with lower volatility.”
  • A growing trend in asset allocation goes beyond the standard 60/40 split between stocks and bonds.  New research suggests a broader and deeper use of asset classes can help to reduce risk.
  • Due diligence is becoming increasingly important as new asset classes in the alternative space emerge.
  • Asset classes are cyclical and respond based on economic environments. Changing economic environments cannot be predicted. Portfolios need to be designed with that in mind.

It’s nice to see new research supporting strategies that  have already been implemented in our client portfolios. If you’re interested in putting the Asset Allocation approach to work in your own investment portfolio, please feel free to contact us.

If interest rates were to rise…

There has been a lot of talk these last few months about what will happen to portfolios when the Fed eventually raises interest rates.  The Fed will only make changes to its low-interest policy when the economy confirms it will continue to improve.  The earliest the Fed would make any changes would be in September, although some experts predict it won’t happen until 2014. Below are a few key points that can help put this into perspective and explain what this means for you:

If interest rates were to rise…

  • Changing trends could provide new investment opportunities.
  • We could see certain domestic bonds decrease in value. Not all bonds but certain types, such as long-term government backed bonds, may be more affected than others when rates do rise. We see opportunities in short duration funds or funds with global diversification or a variety of sub asset classes (such as corporate bonds, senior loans, convertible bonds).
  • It could strengthen the dollar thus making stocks more attractive (both small and large cap could be buying opportunities).
  • The financial sector (regional banks, insurance companies, etc.) could be an opportunity as they historically perform well during periods of rising interest rates.
  • Large Multinational companies based in the US could see their values go down as a result of the strengthened dollar, while multinationals based outside of the US could be a better investment.

Talk about the magic of compounding interest!

I just stumbled upon this interesting nugget.  All things being equal, a 19 year old who contributes $2,000 per year for JUST 7 years will have more money at age 65 than a 26 year old who made $2,000 contributions each year until age 65.

Talk about the magic of compounding interest.  Too bad, most 20-somethings won’t realize this until it’s too late.

For details, read: Investment Advice for Gen Y

New Report on Upward Mobility

NY Times just released the results of a fascinating study about upward mobility in the United States.

The results show that a child who grows up in Bridgeport, CT area with parents who earn in the 10th percentile ($16k), ends up, on average, in the 38th percentile.

These results are indicative of the whole northeast, too.  Unfortunately, the south isn’t so lucky.

Read In Climbing Income Ladder, Location Matters.

3 Negative Views… And How to Spot Them.

The talking heads and supposed experts have done a good job of scaring investors away from the markets.  Their job isn’t to help investors reach their financial goals, rather they are looking to shock investors and make them stay tuned to the channel to learn more (and of course watch their advertisements).

“A connoisseur of woe, needs fresh worries from time to time, or he will become complacent”

Peter Mayle, A Year in Provence

A recent post at dragonflycap.com, has done a pretty good job at classifying these fear mongering talking heads.  Greg Harmon, breaks them into three categories:

The Postponement: Their rhetoric sounds like this, “The big market decline we’ve been talking about is going to happen, just not as soon as I said”.  This camp believes something big is coming and that it’s always right around the corner.  Remember Y2K, the election, the fiscal cliff, and even the recent Fed announcement?

The Rationalization: After a pundit makes a prediction and it turns out to be wrong, his strategy may be to rationalize why some unforeseeable event prevented his prediction from coming true.  It’s easy to explain everything away after it’s already happened.

The Decay: These “experts” look for all the small disappoints and set backs and attribute it to an overall decay of the markets, the economy, the country, etc.  This camp will look into the lowering of the GDP and turn it into something much, much larger.

These mindsets can be debilitating to an investor if they only look for the negative stories.  It’s important to remember these are opinions of people paid to keep you watching the TV and reading their articles.

Four Strategies to Determine Your Asset Allocation.

Asset allocation is an important component to any portfolio.  It deals with the ratio between various asset classes such as stocks and bonds.  Many investors don’t know where to start or how to determine if their asset allocation is appropriate based on their objectives or risk tolerance. Below are four strategies to determine an appropriate asset allocation.  Each one with pros and cons.

  • Rule-of-thumb Formulas are useful for quick planning purposes.  For an investor, this should be a starting point to see if their current allocation is in the ballpark.
  • Risk Tolerance. Investors can complete questionnaires which can identify how comfortable they feel about volatility in their portfolio.  The questions identify how the investor would feel if they were to see their account value decline by X% over various time frames.  Based on their answers, a portfolio is designed around their risk profile.  This is an objective data-driven solution, which many find appealing. But an investor’s risk profile is not static. It changes day to day, depending on their experiences, the news, and a variety of other factors.  When the economy has a negative outlook, an investor’s appetite for risk is usually much lower than when the economy is bullish.
  • Stage of Life.  Age based asset allocations that adjust over time have grown in popularity.  The premise is simple: as an investor gets closer to retirement, his allocation shifts to more conservative asset classes.  This can help reduce the risk of extreme market volatility right before they enter retirement.  The downside, this approach does not factor in personal considerations such as risk tolerance, longevity or financial goals.
  • Goal based. At times, we have built portfolios around a client’s financial goal, such as having $500,000 in assets by the time they retire.  We can show the client the risk factors he/she would take on to try to reach that goal.  This often sparks a conversation with the client about other factors that should be explored, such as increasing the savings rate or adjusting the goal.

If you’re looking to get started, begin with this popular rule of thumb: subtract your age from 110 to determine your stock percentage, put 10% in cash, and the remainder in bonds. From there, you can edge the portfolio to be more aggressive by increasing your stock holdings or more conservative by increasing cash or bonds.

This is starting point, although you should seek professional guidance in determining an asset allocation that will meet your objectives.