Five years ago, Linda and I made a conscious decision. Looking at ourselves and at our client base we came to realize that at our stage of life, managing risk is more important than maximizing returns. After looking at different strategies, it became apparent that to reduce the risk of loss when financial markets were moving down as they did in 2000, 2004 and 2008, we would have to give up some of the returns when financial markets are moving up.
Our research brought us to a strategy developed by Craig Israelson, a finance professor at Brigham Young University that he called the 7/12 Portfolio. In a nutshell, by diversifying the portfolio between 7 asset classes, you end up investing some of the money into assets that have little correlation with each other. One example is commodities and stocks. There is very little correlation in the way these prices move. Generally, when stocks are going up, commodities aren’t doing much. When stocks are going down, commodities are going the other way. So a portfolio with some non-correlating assets generally doesn’t have all assets moving in the same direction at the same time.
In discussing this approach with our clients, it became obvious to us that giving up some returns on the upside was fine if it meant that there was reduced chance of loss on the downside. Based on our experience, diversifying portfolios in this manner tends to provide a smoother ride during bumpy markets.
Unfortunately, during a strong bull market, when we see headlines each day proclaiming that the stock market has set a new record high, it’s easy to lose sight of our strategy and goal. Then you receive a statement on your investments and see that they are underperforming the market indices and you begin to ask yourself, “Why aren’t I getting those kinds of returns?” The answer is simple. You are not meant to.
The goal is to manage risk so that we aren’t continually going up, up, up and then falling down, down, down. The strategy to accomplish that goal is to build and maintain a diversified portfolio with seven separate asset classes that contain some non-correlating assets. The result of this goal and strategy is that we will give up some returns in strong bull markets, but we will not go down as much in bear markets. Put another way, at cocktail parties some of your friends may be bragging about big returns on their portfolio and the next time they will be crying in their martini about how much their investments have lost. That’s when we think you’ll appreciate our strategies the most.
Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is not a guarantee of future results.
Mike Berry is a Registered Representative offering securities through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Legacy Wealth Management, LLC and Cambridge are not affiliated. Cambridge does not offer tax advice.
Copyright ©2013 Mike Berry. All Rights reserved. Commercial copying, duplication or reproduction is prohibited.
