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Portfolio Discipline During Financial And Economic UncertaintyMonday, November 30th, 2015
By Markus Bras, CFP ®, MBA; Director of Pilot Services, American Financial Advisors, Inc.
Once again, we are dealing with uncertainty in the financial markets. During these times it is extremely important to maintain discipline and follow the guidance of the Investment Policy Statement (IPS). This IPS might have been set up when the financial markets were calm and rising, but we were already focused on the possibilities of declining and more volatile markets. We prepare for these markets ahead of time, so that you will be able to maintain discipline when the events actually occur. This is something you did on a daily basis when flying passengers around the world. You prepared a flight plan and took all possible events into consideration. You not only planned with the hopes that it would be an uneventful flight, but had already started the process to plan for uncertain events. You didn’t know what these events would be, when they would happen or where they would take place, but you had a predetermined plan. Your IPS is no different. We established your IPS based on your risk tolerance, risk necessity and time horizon. The IPS is your flight plan. It should give you the confidence, discipline and guidance needed during uncertain financial times.
The volatility in the financial markets during the last few months puts additional emphasis on the following critical steps in building an appropriate investment portfolio.
- Establish an Investment Portfolio which is focused on the long term (10 years +). Money which you will or might need in the short term (0-3 years) should not be invested in the stock market. Keep this money separately invested in a very liquid investment vehicle such as a savings account or money market.
- The short term movements of the financial markets are unpredictable. The long-term success of your investment portfolio is highly dependent on your investment behavior. If you react emotionally to short-term movements, you will put yourself and your portfolio at risk of making poor investment decisions, which will compromise the long-term performance of your investments. Trying to predict what the next move in the stock market is going to be is a futile effort. Not only will you waste a lot of time watching and predicting the short term moves of the market (time which could have been spent with your family or on the golf course) but by being solely focused about what you think is going to happen in the market in the short term, you are very likely to miss out on the best days in the market. Keep in mind that investing for your retirement means you must consider a 25 to 30 year time frame. Short term volatility is not an indicator of long term performance.
- If you have decided that you are going to invest part of your portfolio in the stock market, you will have to accept that market downturns and recoveries are part of the normal course of investing. Because of the inherent risk in investing in the stock market your expected long term rates of return will be higher than those of safer alternative investment choices. Remember that you cannot expect higher rates of return without accepting the associated increase in volatility.
- Rebalance your portfolio at regular intervals. Once you have established an asset allocation, it is critical that you rebalance back to the original allocation when any position becomes either greater or less than its original position. This should never be an emotional decision, but rather a preplanned decision based on the actual asset allocation of your portfolio. Your original asset allocation of your investment portfolio should have been based on factors like risk tolerance, time horizon and withdrawal needs. If you have multiple investment portfolios, you should consider the asset allocation of all investment portfolios combined as well.
- Build a diversified investment portfolio by owning financial securities with low or negative correlation. This will reduce the diversifiable unsystematic risk of your portfolio. The systematic risk of the overall financial markets (consisting of purchasing power risk, reinvestment rate risk, interest rate risk, market risk and exchange rate risk) cannot be diversified away. This is the reason that the systematic risk is also known as non-diversifiable risk. By reducing your unsystematic risk (via a diversified portfolio) and accepting the systematic risks of the financial markets you will be able to accept the inherent volatility of your investment portfolio.
- A diversified portfolio cannot guarantee you positive rates of return but will help you in reducing the risk of your total investment portfolio, so that you will be able to maintain your investment discipline during volatile financial and economic times.
Your Financial Planning team at American Financial Advisors manages your investment assets following the investment principles discussed above. If you have any questions concerning the above mentioned investment philosophy, feel free to contact any of the Certified Financial Planner ™ Professionals at American Financial Advisors.
You have Financial Planning Questions? We have Answers!
Please do not hesitate to contact us if you have any questions or concerns about your Retirement investment portfolio or benefits. We very much appreciate the trust you are placing in our entire AFA financial planning team and me. Your AFA team can be reached at 888-679-9779 at the following extensions and email addresses:
|Mark Bras, CFP®, MBA||ext. firstname.lastname@example.org|
|Leslie Kelly, CFP®, AIF®||ext. email@example.com|
|Joan Morales||ext. firstname.lastname@example.org|
|Bill Mertes, CFA||ext. email@example.com|
|Matt Boyce, CFP®||ext. firstname.lastname@example.org|
|Jim Cable||ext. email@example.com|
|Alex Bras||ext. firstname.lastname@example.org|
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