Asset diversification, allocation can help calm the market’s rough seas
These are uncertain times, they say, and uncertainty impacts the markets and presents a problem for US investors who are still concerned about Enron and possible additional acts of terrorism in the US, not to mention the potential war against Iraq. All of that plays a role in reducing consumer, business and investor confidence.
According to analysts, the events of 9/11 moved the economy from a slowdown into a recession. But the economy bounced back and the recession was short-lived.
Several factors contributed to the quick end of the recession. First was the quick response of the Fed and the fiscal stimulus. Second was the resilient consumer spending. And third was the strong housing market.
The analysts believe our economy is making some progress, so we won’t be witnessing a double dip. Employment posted a modest increase in August, which is another sign that the economy is growing. However, employment is growing at a slow, erratic pace.
While uncertainty remains, logic and conventional wisdom indicate that investors have to find a way to reduce the risks of uncertainty in their portfolios and improve their investment performance. It’s crucial to have a good understanding of asset diversification and allocation, according to Ken Evason, president and chief executive officer of Jacobus Wealth Management in Wauwatosa.
"One thing we’ve seen in the last few years is that the various types of personal investments that business owners, managers and executives have become involved in have produced very diverse rates of return by asset classes, including common stocks," he says. "So we sit down with our clients and help them put together a portfolio of diverse asset classes to either provide the necessary safeguards against one type of asset from doing poorly, or to, in effect, create ways to stabilize their portfolios."
Evason says that protection of principal and maintenance of income are two primary requirements for most high-net-worth individuals. "When you diversify and allocate your assets, you can even things out and protect your principal from big swings," he explains.
"We know that alternative investments in certain types of equities have a low correlation to the stock market. When the market is very weak, portfolios can maintain their value by proactive choices. As an example, there’s a low correlation between real estate investment trusts and the equity market. And a low correlation between government bonds and the stock market. While the overall stock market was down about 22% through the end of August, REITs were only slightly down. And 10-year government bonds have increased in value.
"As another example of this, on a year-to-date basis large-cap growth stocks are down 25% on average. But mid-cap value stocks are down by only six percent."
Chuck Albrecht, first vice president of investments at Prudential Securities in downtown Milwaukee and a financial commentator on WITI-TV, also believes "now more than ever" that there’s a strong need for good asset diversification and allocation in today’s market.
"The big problem here," Albrecht says, "is that many people who had ‘diversified’ earlier thought they had adequately done so because they owned stock in a number of different companies. Unfortunately many of those companies were in the same categories. People concentrated heavily on technology and telecom stocks because that’s where all the money was consistently being made. But when one such stock in their portfolio went down in value, all of them did. Proper asset diversification and allocation in those circumstances would have made sense, because then they would have invested in both growth and value stocks in their portfolios.
"They wouldn’t necessarily have made money, but they would have cut their losses by reducing market risk," he said.
"But there are times that you can get a higher rate of return and not take as much risk," Albrecht says. "And you can do that by diversifying with what would be considered a riskier asset class. For example, adding international securities to a domestic stock portfolio can help reduce overall risk because of their negative correlation. If you invest in two assets that aren’t correlated, that move in opposite directions, that’s good diversification."
David Bier, financial adviser and resident manager of Merrill Lynch in Milwaukee, is another advocate of asset diversification and allocation. "It takes into account all the different financial vehicles out there – stocks, bonds and cash, and tries to balance an investor’s goals with those different classifications," he says. "In this kind of market it’s that much more important to do it so you can smooth out the volatility that’s going on."
To start the process, Bier suggests stepping back and assessing what kind of investor you are, what your goals are and what your risk tolerance is. How much can you take on the downside? How much do you want on the upside? How much return do you need to achieve whatever your goals are?
Investor profiles
According to Bier, there are five different types of investors:
"The latter has kind of faded away, however, in the last couple years because of the volatile stock market," he notes.
"Then you get into how much in stocks you should hold, how much in bonds and how much in cash. The lower you are on the risk tolerance level, the more cash you should have, the higher percentage allocation you make to cash. The higher you go, the more your allocation is to stocks. And in between, there are fluctuations in the percentage of bonds to own."
Bier says there are many factors to consider, but usually an income investor’s portfolio should consist of about 70% bonds and 30% stocks. An income-and-growth investor should probably have 50% stocks and 40% bonds in a portfolio. "But these numbers change with the times and with the situation. The ones that changes consistently are for the aggressive growth investor because the markets will fluctuate more for that person," he says.
"Age, too, comes into play because as you get older and approach retirement age, you tend to go down on the spectrum from that aggressive growth model to capital preservation."
Reassessment
Albrecht, too, counsels assessing your current financial status and reassessing your risk tolerance and needs.
"Determine what it will take to reach your financial goals. Review your portfolio with your advisor at least once a year, maybe quarterly. Sometimes a portfolio can be automatically rebalanced," Albrecht says.
Evason also recommends reassessing your investment objectives at least once a year as well as formulating an investment policy statement that spells out your income needs and risk tolerance.
Evason predicts that the sluggish economy is on the mend, both in the US and globally, with rising economic activity and improving corporate profitability.
"We’re optimistic about an upswing. Our thesis is that there’s no inflation; that fixed-income instruments like bonds aren’t likely to appreciate but aren’t likely to depreciate, either," Evason says.
"We see positioning a portfolio with stocks of growth companies vs. bonds, to participate in the economic recovery. We’re shading our recommendations toward mid-cap growth stocks vs. large- cap growth stocks for value," he says.
"Well diversified and allocated portfolios will benefit from an improved economy," Evason says. "We believe asset diversification and allocation are the biggest determinants of investment performance."
Sept. 27, 2002 Small Business Times, Milwaukee
