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Reassess your risk in light of market changes
Look at the market and your portfolios realistically, and determine your risk tolerance level.
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Investors often equate risk with volatility. Portfolio managers must therefore manage both the portfolio and the risk tolerance of their clients. As the NASDAQ moved ever higher during the 1990s, risk tolerance was high. As markets corrected during the new millennium, risk tolerance suddenly disappeared. With the World Trade Center terrorist attacks highlighting the obvious fact that our markets do correct to the downside, risk tolerance is non-existent for some clients. What is an investor or a money manager to do?
Many investors have lost as much as 50% or 60% of their retirement portfolios over the past 2 years, and I am looking at portfolios that did not hold dot.com companies or initial public offerings that were questionable. I am looking at portfolios that held both blue chip and solid over-the-counter companies such as Dell, Cisco and Microsoft. Now those investors must regroup and move forward with a new, safe plan of action. Investors must make some changes to their portfolios to avoid another financial free-fall, but that does not mean avoiding the markets altogether.
Look at your assets
The first move is to step back and take a solid look at your assets including all portfolios. Determine how much net worth is necessary for retirement and how close you are to that net worth. Many investors planning on early retirement are still planning on early retirement — just not as early. Many investors may have already retired, but they may cut back on spending and travel.
After you assess your situation, you may find that you are comfortable. In that case, you should make some changes to preserve capital. If you find that you have some catching up to do, this requires becoming more aggressive — but not indiscriminately aggressive. Some of the sweeping tax law changes affecting retirement plans might be right for you.
Start your continued investment program by making sure you are maximizing portfolio returns through investments in the most efficient accounts. For example, retirement accounts grow tax-deferred and the new Roth IRA allows for distributions tax-free. New tax laws allow for greater contributions to some of these retirement accounts over the next few years, and many retirement portfolios have some protection from creditors.
Diversify?
Thanks to a two-decade bull market, investors are still sitting well despite the past 18-month decline. A comfortable retirement is well within their grasp. These investors might consider reallocating to some investments that will grow but entail little risk in order to lock in profits. The best means of lowering risk is to diversify holdings. Diversification won’t insulate you from market catastrophes or corrections, but it will soften the blow.
On the negative side, diversification will also lower returns. Some sectors that are perceived as “safe havens” entail risk. Bond portfolios entail risk as well as lower return than stock portfolios. If you own a bond, that bond will return principal in 10 or 20 years plus a certain interest. All of that interest is taxed at ordinary income tax rates, and if you are in a bond fund, that fund may go up or down just as other mutual funds. Be aware of exactly where your investments are positioned and the potential for safety, returns and problems.
Look at the market and your portfolios realistically. Avoid risky stocks such as dot.com companies that do not have any tangible assets. When there is a correction or a catastrophe, don’t immediately sell your companies. Corrections and especially catastrophes are the times for buyers to step in for bargains. We began looking for those sectors that would profit from terrorist activities immediately after the crashes as well as those sectors that would be devastated long-term.
Rebuilding
While history does not necessarily repeat itself and past performance does not guarantee future returns, a long-term backward look at our markets is promising. History does suggest that markets run on demographics and spending of large population groups. This gives us some guidance in our look toward the future and where to position portfolios for the best returns at the lowest risk ratio.
Rebuilding our country means that companies involved in infrastructure will be busy. Information is absolutely necessary to run the world, so those firms well positioned to improve information highways and keep us in communication will profit. This sector includes such companies as those that make cell phone components and those firms that specialize in storing and high speed retrieval of information.
Security is a serious concern in the United States for the first time ever. It is quite probable that many of our major companies will increase security at their facilities. Airports and government offices will certainly beef up security procedures. More and better scanners may be installed at various locations, both airports and other public transportation facilities.
Decentralization is an issue because no company wants to see the majority of its brainpower or facilities wiped out by one attack. Such decentralization can bleed into the communication and data storage sectors. Decentralization means more employees may work from home with the necessary computer and communication such employees will require. Rural growth may be imperative as people able to do so move away from cities.
Repositioning
Now that you know how you want to reposition your portfolios, look at your real risk tolerance and your real time frame. Growth stock portfolios are long-term investments. If you require funds next year or the year after, those funds must be placed in a more conservative and less volatile market sector.
There are several means of arriving at the same destination. For example, if you ask me how to travel from Denver to New York City, I can suggest walking, the train, auto, air travel, etc. While all of the above will help you reach your destination, the most cost-effective and timely would be air travel.
By the same example, if you want to arrive at your retirement destination with a certain amount of net worth and are beginning the journey with a certain net worth, your time frame will determine the amount of risk necessary to make that journey in the most feasible manner. It is my opinion that we are at a crossroad that will bring our markets back on track and our general economy back on track over the next few years. Astute investors should try to participate fully.
Discuss with your investment professional any changes in your time horizon or risk tolerance at least quarterly. Remember your time horizon. Study the overall, long-term outcome of investing in our markets, and please remember this is the strongest economic system in the world. Our strong companies will continue to reward shareholders.