Your Investments: Greek aftermath

What to do with your portfolio after the EU bailout.

By AARON KATSMAN
May 22, 2010 05:33
3 minute read.
Aaron Katsman

Aaron Katsman 58. (photo credit: Courtesy)

I have been inundated by clients wanting to know what to do with their investment portfolios in the aftermath of the European Union’s bailout of Greece. Clients want to know whether this is an isolated crisis contained to Europe or if it could spread globally.

That stock markets around the world have plunged may be due to mass profit taking after a furious market rally from the market bottom of 15 months ago. A natural market phenomenon, profit taking, is being justified by using the Greek bankruptcy as an excuse. Conversely, the market drop could be attributed to a growing concern that countries such as the US and, even more imminently, Japan could face a similar fate as the Greeks.

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For long-term investors, I think there is a need to take a step back and view the current events with a bit of perspective. History is replete with all kinds of economic crises, and eventually things tend to sort themselves out.

Many financial advisors would recommend that investors do absolutely nothing to their portfolios, hold tight and ride out the wave. They will produce all kinds of historical information about returns of various assets and the need to stay the course. They will say their investment models produce efficient portfolios with limited risk and volatility. Sounds like the best of all worlds. Great returns and low volatility!

So why don’t investors see this benefit in the monthly statements they receive?

How does one define the time frame of “eventually things tend to sort themselves out”? After all, many major stock-market indices haven’t budged in over a decade. How long are investors expected to be slaves to classic asset-allocation models before they realize that not only are they not making any money, but that all the promised stability never materialized?

Maybe it’s time for investors to try a new approach: add value to their portfolios, and potentially increase profits, and leave behind the classic “buy and hold” asset-allocation model.

STRATEGIC ASSET ALLOCATION
Classic asset allocation can be loosely defined as an investment strategy that aims to balance risk and reward by apportioning a portfolio’s assets according to an individual’s goals, risk tolerance and investment horizon. The three main asset classes – equities, fixed-income, and cash and equivalents – have different levels of risk and return, so each will behave differently over time.

The downside to this strategy is that it doesn’t really change as markets do and it provides little value added. It’s very static, and investors may suffer. If an investor sees that the economic fundamentals in Western Europe are lousy and there are all kinds of structural problems as well, why continue to invest there?

That’s where strategic allocation comes into play. Investors can look at certain macroeconomic or microeconomic data, country growth forecasts, stock valuations, etc. and decide whether an investment is appropriate at this time. It allows investors to think strategically to decide on the right investment mix based on today’s current climate – not based on models that use 100 years of data to determine investment policy (which has little relevance to current reality).

To illustrate this point, it used to be that allocation models would call from anywhere between 5 percent to 10% of a portfolio to be held in cash. This was great when cash deposits actually paid 4%-6% interest. If you use a model based on 100 years of historical return, you would expect to get a 4%-6% return on cash. Well, as we all know, investors today get virtually nothing on cash deposits; so by keeping up to 10% of your portfolio in cash, you are basically writing off any return for a significant part of the portfolio. We like to refer to that as “dead money.”

Strategic allocation would take this into account, and a 2%-3% short-term, interest-paying bond would potentially be suggested instead as an alternative to cash.
Investing strategically requires a more hands-on approach and may not be for all investors or advisors. Speak to your financial advisor to see if this strategy fits your investment profile.

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Aaron Katsman, a licensed financial adviser in Israel and the United States, helps people who open investment accounts in the US.


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