Recasting the Golden Rule:
diversification after the crisis
Up to 90% of your overall returns can be attributed to how your portfolio is divided among the three main asset classes: cash, fixed income and equities. This first measure of diversification is the most important factor when balancing risk tolerance with higher returns, relative to your goals and overall comfort level with risk.
Before the financial crisis, growth-oriented investors focused on equities (e.g. stocks) that typically produce higher returns over a long-term investment timeline. Yet, when the financial crisis hit, many investors shifted to “safer” fixed-income and cash products such as bonds and GICs. That was a year ago. Now it’s time for investors to get back on track. With new market activity and a revised economic outlook in store, now may be the time to re-diversify and add some high-quality stocks to your portfolio to take advantage of long-term growth potential ahead.
Finding your real comfort level with risk
With equilibrium returning to the markets, re-assess your real, honest comfort level with risk. We underscore “real and honest” because often, when the markets are performing well, investors are wooed by great returns and feel a false sense of security, taking on more risk than they are truly comfortable with. During periods of poor performance, like the crisis of 2008, they realize that they were not very comfortable with risk after all, and enter “panic mode” – quickly selling assets or exiting the markets entirely. Now is the time to understand your own tolerance for risk, and how to negotiate that with your desired returns, income needs and investment timeframe.
Putting it together: Diversify your risk tolerance
Just as there is no one-size-fits-all approach to investing, there is no one-size-fits-all approach to managing risk. Dalbar, the research firm known for its annual report on investor behaviour, recommends a strategy called Purpose-Based Asset Management in which you arrange your portfolio based on different goals (retirement, saving for a big purchase, your child’s education or wedding) and assign a specific risk tolerance to each goal.
This way, you can be more conservative with your retirement or your child’s education, but can accept greater risk when saving for a big purchase.
With this approach, you can take some risk while you know that you aren’t being reckless with core retirement or future savings.
Markets change, but successful investment strategies are timeless
If your “crisis” portfolio model shifted dramatically – say from a long-term growth model to “money-stuffed-under-a-mattress” model – don’t let it remain that way as the markets recover. You could be left in the cold as other investors begin to rebuild their wealth. Many investors re-tuned their investment portfolios in time to take advantage of the recent stock market uptick. If you think it’s too late for your portfolio to take advantage of the recovery, don’t lose hope. Retain a long-term view to investing and you can still take advantage.
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