ON THE MONEY: There are no guarantees when playing the stock market

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By John Grace

Contributing Columnist

Is now a good time to invest in stocks?

My best answer is, that regardless of age, it depends on your appetite for potential loss. We have the pleasure of working with engineers, from aerospace to biomedical to automotive. Engineers as a group detest sales material and pie-in-the-sky thinking. They prefer intelligent arguments rooted in facts and math.

Starting in 2007, we began employing an actively managed strategy for our clients so that risky assets may have been repositioned to less volatile positions like money market funds or bonds. While some of our clients, based on their appetite for risk, saw their cash position go from 5% at the beginning of the year, to 40% at the end of 2008, others finished 2008 with 100% in money market accounts.

Each situation is customized to the loss parameters set by each investor. By reducing the loss in down markets, it takes less of a gain to get back to even. For example, if your account is down 20%, it takes a gain of 25% to get back to even, but if your account was down 50%, it takes a gain of 100% to get back to even.

Savvy investors are inquiring about different strategies to help manage risk and smooth out the wild roller coaster ride of the stock market.

Following the practice of active management is for those who would prefer to stay in the game without a hail-Mary pass just to get back in the game.

The second method savvy investors have learned to employ is greater diversification. When we look at Yale University’s endowment fund, for an example, www.investments.yale.edu, we see that they no longer rely on traditional asset classes.

“Today, domestic marketable securities account for less than one-10th of the portfolio, while foreign equity, private equity, absolute return strategies, and real assets represent over nine-10ths of the endowment,” the Yale website says. “The heavy allocation to non-traditional asset classes stems from their return potential and diversifying power. Today’s actual and target portfolios have significantly higher expected returns and lower volatility than the 1985 portfolio.”

While, for various reasons, retail investors can’t do the exact same work, we can all learn from Yale’s example and look to add more asset classes to diversify accounts. We can all agree having five asset classes under any portfolio makes for a stronger foundation than two or three legs under your portfolio stool.

Investors are often asked are you conservative, moderate or aggressive? We find that we can pose much more constructive questions.

It is our practice to ask a series of questions about possible losses that include the amount of money and the ratio of loss. While there are no guarantees, it may be possible for investor losses to be maintained within their parameters as opposed to discovering how low we can go.

The reason this is so important is thanks to Dent Research we would not be surprised to see a prolonged recession. Instead of allowing investors to be kicked in the assets, our goal is to limit losses as much as possible so that clients can not only have a nice day but be prepared to catch the next wave.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

John Grace is a registered representative with LPL Financial. His On the Money column runs monthly in The Wave. The opinions expressed here for general information only and are not intended to provide specific advice or recommendations for any individual.

 

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