Today’s Stock Market and Your Portfolio Allocation
There are two schools of thought on how to design an investment portfolio. In the first, a “static approach”, an investor puts together a collection of diversified stock and bond funds and leaves it alone, except for periodic rebalancing. In the second school of thought, a portfolio allocation should change over time to reflect the changes and dynamics presented by the stock and bond markets.
The static approach offers broad diversification, but based on the portfolios following this approach, I have found that stocks and mutual funds had poor performance or were extremely volatile over the years. This approach is called Modern Portfolio Theory, and is used by many financial advisors.
Richard Haworth wrote an article in Pensions and Investments entitled, “2008 revealed flaws in modern portfolio theory”. He points out, “2008 is the year everything in finance went wrong. It highlighted the dangers of everyone slavishly following modern portfolio theory with its deceptively flawed assumptions of constant volatility and correlation. The theory simply ignored grave potential dangers.”[i]
The second approach is to continue to use a diversified portfolio approach, but to use it in a way that adapts to current market conditions. I call it a “modified buy and hold” approach. It is apparent to me that the market is currently overextended and seems to have more downside risk than upside potential. In view of the risks associated with the current market, I am cautiously invested in equities and bonds in my buy and hold approach, avoiding the more volatile sectors. I am also partially invested in government bonds.
I believe that at some point the market will reverse and even go through another collapse – or at least a significant correction, based on historical patterns. When a market correction happens, I believe that my approach to a diversified portfolio will minimize downside losses. Following a market correction, I will reallocate my client’s portfolios and focus more on growth-oriented equities at that time – when their prices get cheaper. Patience and belief in historical patterns is inherent in this approach.
Walter Updegrave explains in a recent article in www.time.com/money, “5 Simple Steps to the Perfect Portfolio”. He warns, “Despite what many Wall Street firms and advisers may suggest, you don’t need to stock your portfolio with an ever-expanding array of funds and ETFs to navigate today’s global financial markets. In fact, such a portfolio may do more harm than good. Here’s how to tell whether you’re diversifying or di-worse-ifying.”[ii] Here are the five simple questions he asks.
Do you need the fingers of both hands to count your investments?
Do you own investments you don’t really understand?
Can you explain exactly why you bought each investment you own?
Do you own investments that you’ve never touched after buying?
Do you regularly add new investments to your portfolio?
If you tackle these simple questions thoughtfully, I believe that you can develop a portfolio best suited to your needs and that is also relevant to today’s market conditions.
Ben Reppond is CEO and Investment Manager of Reppond Investments. Reppond Investments, Inc. is a registered investment adviser in the States of Washington and Montana. We may not transact business in state where we are not appropriately registered, excluded or exempted from registration. Individual responses to persons that involve either the effecting of transactions in securities, or the rendering of personalized investment advice for compensation will not be made without registration or exemption.
Investment Advisory Services offered through Reppond Investments, Inc.
[i] Updegrave, Walter, http://time.com/money/collection-post/3263186/diversifying-portfolio-5-rules/
[ii] Haworth, Richard, Pensions and Investments, June 20, 2012, http://www.pionline.com/article/20120920/ONLINE/120929999/2008-revealed-flaws-in-modern-portfolio-theory