Market uncertainty is a certainty. Trade War, Federal Reserve, Tariffs, Brexit, Politics, Interest Rates, Hong Kong, Middle East, and the list goes own. The world is an unpredictable place and it impacts financial markets and stocks. You have three ways to handle market uncertainty which is always with us but sometimes more intense than others.
- Reduce your equity exposure by buying fixed income instruments or raising cash. This method clearly lowers your risk profile but also lowers your expected return and in today’s very low interest rate environment lowers your yield. The U.S.10-year treasury bond is only yielding 1.6% currently. The stock market yield as measured by the S&P500 is higher than 1.6% and if you focus on dividend paying stock portfolio you can get a yield north of 3% (granted with the risk and volatility of stocks). Risk reduction with bonds is not without its cost, lower yield and lower expected return is the cost.
- Handle risk reduction by first including some fixed income instruments in your portfolio, but in addition to that, utilizing other diversifying assets to lower exposure to stock market volatility. These other assets have reasonable expected returns but are not risk free nor low risk; however, if these assets are uncorrelated with the stock market, they lower risk through diversification, not having all your eggs in one basket. Diversifying investments include real estate, reinsurance, timberland, infrastructure, various risk premium capture, alternative lending and few other less know asset classes. These types of investments have a low correlation with the stock market and still have higher than bond expected returns, possible expected returns of 6% or higher makes them a great place to lower your equity exposure, lower equity risk, while maintaining your exposure to investments with reasonable expected returns. This is more important today with interest rates at extremely low levels than it is ever been. Most investors should investigate whether diversifying assets would make sense for them.
- Utilize uncertainty and down markets to buy more stock at lower prices, lower prices mean a higher expected return. While this is not appropriate for all investors, it may be appropriate for investors in the accumulation phase or investors who are investing for future generations. This choice does not work for an investor with a short time horizon or is taking significant regular withdrawals out of the portfolio. The investor with the luxury of time can maintain equity exposure and utilize any potential sell-offs as an opportunity to buy more stocks at lower prices. Younger investors and generational investors have long multidecade horizons allowing for plenty of time for the stock market to recover and grow. With that long-term horizon, a market downturn over 2 or 3 years is an opportunity to invest for the future and not a constraint on what can be taken out of the portfolio.
These 3 methods: allocating to fixed income and cash, supplementing that allocation with diversifying assets, or holding and buying more in a downturn are appropriate for different investors with different goals, risk tolerance, and time horizons. You should evaluate with your financial advisor what method for handling uncertainty is best for you. For more information on your second option, you can download a couple of free chapters of my book, Wiser Investing, Diversify Your Portfolio Beyond Stocks and Bonds.
The information is for informational purposes only. The opinions expressed or implied are exclusively those of the writer and are not to be attributed to, or presumed to be endorsed by, the author’s employer or any company with which the author is affiliated, and are subject to change without notice.
The information has been derived from sources believed to be reliable, but its accuracy and completeness are not guaranteed. Investing in stocks, bonds, and other assets which present various forms of risk to investors could result in losses and positive returns are not guaranteed. Diversification only reduces the risk of capital loss but does not eliminate this risk. Measures of expected return and/or expected risk are not forecasts of returns or risks but are only statistical definitions for modeling purposes based upon financial and statistical analyses. Past performance is no indication of future results, and all investments or assets could lose value in the future due to a variety of financial factors. Due to volatility exhibited in various markets, including but not limited to stocks, bonds and other forms of investable assets these markets may not perform in a similar manner in the future. Among risks which can affect value, financial assets are also exposed to potential inflation and liquidity risks. Expected returns, expected risk, and long-term targeted returns are not forecasted returns or risks but are only statistical definitions for modeling purposes. Investors may experience different results in any chosen investment strategy or portfolio depending on the time and placement of capital into any assets associated thereto. Diversified strategies are constructed to diversify from an all-bond portfolio, directed toward investment among assets that may largely, though not necessarily completely, be non-bond alternatives. Investors are cautioned that they should carefully consider fully diversifying their total personal investment allocations to incorporate a variety of investment assets which also may include stocks, stock mutual funds and ETFs, international assets, bonds and fixed income instruments (where appropriate), and other non-stock/bond investments (e.g., without limitation, Real Estate and other assets). Nothing should be considered a recommendation nor a solicitation to buy or an offer to sell shares of any security or service in any jurisdiction where the offer or solicitation would be unlawful under the securities laws of such jurisdiction.