The Asset Allocation Puzzle

Possessing a considerable amount of knowledge about stocks, bonds, and cash is only a small part of the investment planning process. Many investors are under the false notion that the greatest determinant of
portfolio performance is the specific investment choices they make. Actually, the biggest decision you will make is how much to allocate to different investment categories.

Asset allocation is all about finding the mix of investments that is right for your situation. Goals, time horizon, risk tolerance and risk capacity are some of the key factors that should be considered when allocating assets.

Goals

Determining what asset allocation is appropriate depends largely on the goals you seek to achieve. Are you saving for retirement, college education for your children, or a vacation home? Each goal must be considered in creating the appropriate asset mix.

Time horizon

Time horizon is the length of time a portfolio will remain invested before withdrawals are made. If your investment horizon is fairly short, you’d likely want a more conservative portfolio—one with returns that do not fluctuate much. If your investment horizon is longer, you could invest more aggressively.

Risk Tolerance

Everyone has a different emotional reaction to sudden changes in their portfolio value. Some people have trouble sleeping at night, while others are unfazed by fluctuations in the market. Risk tolerance is a personal preference and should be tailored to you specifically. However, when determining an appropriate asset allocation mix, it is important to consider not only one’s risk tolerance, but also one’s risk capacity.

Risk Capacity

An investor’s risk tolerance refers to his or her aversion to risk, while an investor’s risk capacity relates to his or her ability to assume risk. Sometimes, an investor’s risk capacity and risk tolerance do not match
up. If an investor’s capacity to take risk is low but the risk tolerance is high, then the portfolio should be reallocated more conservatively to prevent taking unnecessary risk. On the other hand, if an investor’s risk capacity is high but the risk tolerance is low, reallocating the portfolio more aggressively may be necessary to meet future return goals. In either
case, speaking with a financial advisor may help to determine if your risk tolerance and risk capacity are in sync.

Have questions or need a second opinion? Contact us today to learn more or to schedule a free consultation.

PFG Private Wealth Management, LLC is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. This material and information are not intended to provide tax or legal advice.  Investments involve risk and, unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

January FOMC Meeting: A pause, but (probably) not the end of tightening

Leading into the Federal Open Market Committee (FOMC) decision, Chair Jerome Powell and many of the regional Federal Reserve (the Fed) bank presidents had unanimously expressed support for a pause in the Fed’s tightening cycle. Even Esther George, from the Federal Reserve Bank of Kansas City, advocated for a patient approach to monetary policy in her speech a few weeks ago.

In a press conference following the conclusion of the FOMC meeting, Powell stuck to the script and emphasized the Fed is waiting patiently to see how the economy evolves. The January statement removed the reference to further gradual increases, scrapped the central bank’s assessment that risks to the economic outlook are roughly balanced (hinting that they are skewing slightly to the downside now), and noted that inflationary pressures are muted. Translation: the Fed is on hold until at least June. The battery of dovish tweaks to the Fed’s guidance was enough to lift U.S. equities in the minutes following the announcement.

The cause for the pause: Downside risks

It’s important to remember that the cause for the pause is most likely about emergent downside risks to both the U.S. and global economic outlook. While the Fed still expects a strong economy in 2019, the recent volatility in financial markets, the slowing in global growth, and sharp declines in measures of U.S. consumer and business confidence have all eroded the central bank’s conviction in that baseline somewhat.

A Message From Your Portfolio Managers

Volatility will always be around on Wall Street, and as you invest for the long term, you must learn to tolerate it. Rocky moments, fortunately, are not the norm.

Since the end of World War II, there have been dozens of Wall Street shocks. Wall Street has seen 56 pullbacks (retreats of 5-9.99%) in the past 73 years; the S&P index dipped 6.9% in this last one. On average, the benchmark fully rebounded from these pullbacks within two months. The S&P has also seen 22 corrections (descents of 10-19.99%) and 12 bear markets (falls of 20% or more) in the post-WWII era.

Even with all those setbacks, the S&P has grown exponentially larger. During the month World War II ended (September 1945), its closing price hovered around 16. At this writing, it is above 2,750. Those two numbers communicate the value of staying invested for the long run.

 This current bull market has witnessed five corrections, and nearly a sixth (a 9.8% pullback in 2011, a year that also saw a 19.4% correction). It has risen roughly 335% since its beginning even with those stumbles. Investors who stayed in equities through those downturns watched the major indices soar to all-time highs.

 As all this history shows, waiting out the shocks may be highly worthwhile. The alternative is trying to time the market. That can be a fool’s errand. To succeed at market timing, investors have to be right twice, which is a tall order. Instead of selling in response to paper losses, perhaps they should respond to the fear of missing out on great gains during a recovery and hang on through the choppiness.

After all, volatility creates buying opportunities. Shares of quality companies are suddenly available at a discount. Investors effectively pay a lower average cost per share to obtain them.

 Bad market days shock us because they are uncommon. If pullbacks or corrections occurred regularly, they would discourage many of us from investing in equities; we would look elsewhere to try and build wealth. A decade ago, in the middle of the terrible 2007-09 bear market, some investors convinced themselves that bad days were becoming the new normal. History proved them wrong.

As you ride out this current outbreak of volatility, keep two things in mind. One, your time horizon. You are investing for goals that may be five, ten, twenty, or thirty years in the future. One bad market week, month, or year is but a blip on that timeline and is unlikely to have a severe impact on your long-run asset accumulation strategy. Two, remember that there have been more good days on Wall Street than bad ones. The S&P 500 rose in 53.7% of its trading sessions during the years 1950-2017, and it advanced in 68 of the 92 years ending in 2017.3,4

 Sudden volatility should not lead you to exit the market. If you react anxiously and move out of equities in response to short-term downturns, you may impede your progress toward your long-term goals.  We are continually monitoring and evaluating your portfolio and will make adjustments when necessary.

Thank you for your trust,

PFG Private Wealth Management, LLC

News by the Numbers

Five noteworthy figures from the previous week

$60 billion
The amount of Chinese imports to the U.S. that may soon face tariffs.

Following up on the newly imposed excise taxes for imported aluminum and steel, the Trump administration plans a second round of taxes on as much as $60 billion worth of Chinese goods heading to the U.S. The list of specific products subject to the tariffs may not be finalized until May.

Source: Washington Post

 

3
Consecutive months that new home sales have fallen.

Economists surveyed by Reuters expected a 4.4% rise in sales for February, not the 0.6% decline that the Census Bureau announced Friday. At $326,800, the median price of a new home last month was 9.7% higher than it was a year earlier.

Source: Reuters

 

197,000
Net monthly job growth since the Federal Reserve began tightening at the end of 2015.

The central bank has gradually increased the benchmark interest rate with the belief that the economy is strong enough to tolerate such policy change. The economic gains recorded since then have affirmed the Fed’s view.

Source: New York Times

 

62%
The percentage of Americans unaware that the Fed raised interest rates in 2017.

Conducting a survey on behalf of personal finance website NerdWallet, the Harris Poll garnered this result; they surveyed 2,000 U.S. adults who were at least 18 years old.

Source: Detroit Free Press

 

4.75%
The new prime lending rate at most major banks.

This was 4.5% prior to last week’s Federal Reserve interest rate move. The prime loan rate rises or falls in step with changes in the federal funds rate, and it is the base rate that banks use to set interest rates on short-term commercial and consumer loans.

Source: Business Insider

 

Eleven Ways to Help Yourself Stay Sane in a Crazy Market

Keeping your cool can be hard to do when the market goes on one of its periodic roller-coaster rides. It’s useful to have strategies in place that prepare you both financially and psychologically to handle market volatility. Here are 11 ways to help keep yourself from making hasty decisions that could have a long-term impact on your ability to achieve your financial goals.

Have a game plan

Having predetermined guidelines that recognize the potential for turbulent times can help prevent emotion from dictating your decisions. You can use diversification to try to offset the risks of certain holdings with those of others. Diversification may not ensure a profit or guarantee against a loss, but it can help you understand and balance your risk in advance.

Know what you own and why you own it

When the market goes off the tracks, knowing why you originally made a specific investment can help you evaluate whether your reasons still hold, regardless of what the overall market is doing. Understanding how a specific holding fits in your portfolio also can help you consider whether a lower price might actually represent a buying opportunity.

Remember that everything is relative

Most of the variance in the returns of different portfolios can generally be attributed to their asset allocations. If you’ve got a well-diversified portfolio that includes multiple asset classes, it could be useful to compare its overall performance to relevant benchmarks. If you find that your investments are performing in line with those benchmarks, that realization might help you feel better about your overall strategy.

Even a diversified portfolio is no guarantee that you won’t suffer losses, of course. But diversification means that just because the S&P 500 might have dropped 10% or 20% doesn’t necessarily mean your overall portfolio is down by the same amount.

Tell yourself that this too shall pass

The financial markets are historically cyclical. Even if you wish you had sold at what turned out to be a market peak, or regret having sat out a buying opportunity, you may well get another chance at some point.

Be willing to learn from your mistakes

Anyone can look good during bull markets; smart investors are produced by the inevitable rough patches. Even the best investors aren’t right all the time. If an earlier choice now seems rash, sometimes the best strategy is to take a tax loss, learn from the experience, and apply the lesson to future decisions.

Consider playing defense

During volatile periods in the stock market, many investors reexamine their allocation to such defensive sectors as consumer staples or utilities (though like all stocks, those sectors involve their own risks, and are not necessarily immune from overall market movements). Dividends also can help cushion the impact of price swings.

Stay on course by continuing to save

Even if the value of your holdings fluctuates, regularly adding to an account designed for a long-term goal may cushion the emotional impact of market swings. If losses are offset even in part by new savings, your bottom-line number might not be quite so discouraging.

Use cash to help manage your mind-set

Cash can be the financial equivalent of taking deep breaths to relax. It can enhance your ability to make thoughtful decisions instead of impulsive ones. If you’ve established an appropriate asset allocation, you should have resources on hand to prevent having to sell stocks to meet ordinary expenses or, if you’ve used leverage, a margin call. Having a cash cushion coupled with a disciplined investing strategy can change your perspective on market volatility. Knowing that you’re positioned to take advantage of a downturn by picking up bargains may increase your ability to be patient.

Remember your road map

Solid asset allocation is the basis of sound investing. One of the reasons a diversified portfolio is so important is that strong performance of some investments may help offset poor performance by others. Even with an appropriate asset allocation, some parts of a portfolio may struggle at any given time. Timing the market can be challenging under the best of circumstances; wildly volatile markets can magnify the impact of making a wrong decision just as the market is about to move in an unexpected direction, either up or down. Make sure your asset allocation is appropriate before making drastic changes.

Look in the rear-view mirror

If you’re investing long term, sometimes it helps to take a look back and see how far you’ve come. If your portfolio is down this year, it can be easy to forget any progress you may already have made over the years.

Take it easy

If you feel you need to make changes in your portfolio, there are ways to do so short of a total makeover. You could test the waters by redirecting a small percentage of one asset class to another. You could put any new money into investments you feel are well-positioned for the future, but leave the rest as is.

 

PFG Private Wealth Management, LLC is a Registered Investment Adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities product, service or investment strategy.  Investments involve risk and unless otherwise stated, are not guaranteed.