How to protect your financial portfolio from yourself

When it comes to investing, people tend to chase performance — looking at what worked last year at precisely the wrong moment.

And it’s no different now. Investors are asking, “If the market hit new record highs last year, why didn’t my portfolio reflect that?” “Why should I bother investing overseas, when only the U.S. market is doing well?” “Does diversification still work?”

That last question is concerning, because diversification remains critical, whatever the market environment.

“Whenever people think it’s no longer important, that’s when it matters most. That’s when you wish you’d stuck with your guns, instead of changing to something that has worked in the recent past and is just about to change,” says Andrei Voicu, CFP®, AIF®, chief investment officer at Fragasso Financial Advisors.

Smart Business spoke with Voicu about portfolio allocations and the current market.

How much do market conditions impact portfolio allocation strategies?

As investors, you need to stay humble and recognize the fact that predicting the future is very difficult. For example, last year many feared interest rates would rise, when in fact they declined. That’s why diversification and a balanced approach are so important. You don’t want to bet the house in one direction.

At the same time, some things don’t need to stay static; you can adjust certain values over time, given the market conditions. You would invest differently today with interest rates so low, than 10 years ago when they were significantly higher.

It’s important to have a diversified core that does not change — it only changes if your life goals change. That’s your major allocation of stocks, bonds, etc., which are based on your age, goals and cash flow needs.

Then, at the edges you can make adjustments along the way to respond to oil prices, currency or interest rates. But whenever you make an adjustment, consider: ‘What’s the worst case scenario?’ ‘Can I afford to be wrong?’ ‘How am I going to recover if I’m wrong?’ The answers dictate how much you want to respond to market conditions.

How should an investor set up a portfolio?

With the help of your adviser, you’ll want to start with your long-term goals. Then, figure out what is the real return that you require, how much risk you’re comfortable with and how you feel about losing X percent of your money in any given year.

The safest course is an indexed portfolio that gives you diversified access to the various markets. Then, you can look to improve upon your returns with different strategies — but only at the margin. If you happen to be wrong, you want to come back and fight another day.

But once you’ve determined a course, it’s possible your risk tolerance could change when market losses actually materialize. You may have said you’d be comfortable with a 10 percent loss, but you’re really not when it happens.

Or perhaps your goals and expectations need to be adjusted, as you go through life changes like having kids. There’s always a give-and-take that’s part of the ongoing part of planning.

When investors get nervous about the market or their portfolio’s performance, how does your firm advise them?

You should have already determined the proper allocation for the long term. And assuming things have not changed with that, there’s no reason to change the allocation if the market goes down. It’s actually counterproductive because you’re selling low and buying high when you feel comfortable.
Your adviser will try to re-educate you about how markets move up and down, and how they recover. If you sell when your heart tells you, it’s probably the worst time.

If you’re still nervous, you can create a cash cushion or hedge the portfolio as incremental steps to keep you on course as much as possible. It’s important that you don’t make temporary losses into permanent ones by selling at the bottom.

Set a plan based on knowing yourself and understanding how you react, and stick to that plan. Do you tend to panic? Do you watch the financial markets every day? This allows you and your professional adviser to put together the right mix for your future, and set processes in place to guard your portfolio against yourself and knee jerk reactions.

Insights Wealth Management is brought to you by Fragasso Financial Advisors