Quarterly Thoughts – Q1 2011
“The only certainty is that nothing is certain” ~ Pliny the Elder, First century Roman. Despite major unrest in parts of Northern Africa and the Middle East, a massive earthquake, the subsequent tsunami and partial nuclear meltdown in Japan, renewed sovereign debt concerns in Europe, and continuing inflationary pressures in certain emerging market countries, the global economic recovery pushed on. If recent events teach us all anything, it is that uncertainty is unavoidable, and that there is no crystal ball. Maintaining reasonable expectations and managing risk is half the game.
Stay on track and manage risk through the following steps, remembering that market volatility is usually a less dangerous risk than longevity risk (the risk of running out of money) and inflation (the loss of purchasing power):
• Step One: Match risk levels to your needs – Clarify and quantify your goals, and identify the asset allocation (e.g. stocks vs. bonds) with the least amount of expected risk that is likely to achieve those long-term goals. By only taking the level of risk that is necessary to meet your needs, you reduce the chance of unnecessary shocks and the investor behavior problems that can follow.
• Step Two: Diversify – WealthStep designs portfolio asset allocations and selected money managers (i.e. mutual funds, etc.) carefully diversify within each asset style, to maintain percentage limits, and therefore risk limits, to any given company, industry, sector or region.
• Step Three: Stay Balanced – Portfolios are systematically reviewed and rebalanced back to your target asset allocation, so that your portfolio never strays too far from your intended risk profile. This portfolio pruning tends to reduce risk and improve returns in the long-run, by systematically “selling high” with a small portion of the portfolio, and then “buying low.” Rebalancing also helps to protect against events that simply can’t be anticipated.
• Step Four: Monitor – Regularly revisit steps 1-3 ensure that portfolio design is consistent with your evolving goals.