portfolio strategy for the long haul

Recent stock market volatility may be with us for a while as we head into Octobera historically dangerous month for stocks. Positioning portfolios to weather the inevitable storms is the key to success.

Investing in the stock market can lead to losses, or so the widely-used disclaimer goes. And it is absolutely true. The stock market goes up, and the stock market goes down─sometimes violently. 

It is also true that historically stocks have provided investment returns that beat most other investments, which is why we invest in stocks in the first place. This is why Warren Buffett invests in stocks.

After more than a year of rising stock prices, the market began to weaken in September. As of early October, the S&P 500 is down more than five percent from its recent high. And as we know, October is an historically difficult month for the market, so this downward volatility may stick around for a while.

Instead of getting into the reasons for why the market may be heading higher or lower (there are good reasons on both sides) it might be more profitable to take a step back and review how stocks fit into a portfolio in the first place, and how stock market risk can be mitigated through thoughtful portfolio construction.

A Customized Portfolio is Key

An individual’s portfolio has to be more nuanced than simply going for the highest returns, or following the safest route possible. Put another way, there is not a right or wrong mix of investments, only trade-offs.

For instance, a portfolio heavily weighted in stocks makes sense for someone with a long time horizon and little concern for dramatic swings in portfolio value. Conversely, a retired investor living off their portfolio can not take the risk of a big drop in their portfolio when they might not have the time to make up for those losses.

Still another important factor─and one that often gets overlooked─is investor psychology. When stocks are rising, and portfolio values are trending handsomely higher, investors feel good. It is only natural. Having more is better. But this is where things can get tricky. Too often we as humans look at our higher portfolio value and think it’s “in the bank.” In other words, we often feel that we’ve earned those gains and now they are ours.

In reality, our investments will lose value from time to time. And for many of us, it is painful to watch our money─the money we believed we had earned─being taken away. This often leads to second guessing. “Should I have sold?” “What should I be doing differently?” “Will the market keep going down?” “Should I change my portfolio?” Or my personal favorite: “Should I sell now, then get back in later at lower prices?” (To be fair, this is completely logical, but it is impossible to execute because we never know with any certainty if the market will continue lower, or rebound higher leaving us kicking ourselves for selling.)

There is a better way.

SilverPeak Wealth constructs portfolios using three broad types of investments: stocks, bonds, and real estate. All are important because they bring different elements together to create a balanced portfolio that can meet a number of different needs, but it is not a one-size-fits-all solution. Instead, SilverPeak Wealth uses these three broad categories in different proportions based on what a client is trying to achieve.


Stocks

As mentioned, stocks provide superior long-term growth, but they are volatile and investors can suffer serious losses in the short term. SilverPeak Wealth encourages clients to view the stock portion of their portfolio as very long-term. We want our clients to understand that this portion of their portfolio will rise and fall in the short-term, but is highly likely to grow substantially over the long term.

For these reasons, the stock portion of the portfolio should be large enough to contribute meaningfully to the long-term performance of the portfolio, but not so large that a sharp drop in the stock market will jeopardize the overall goals of the portfolio or cause an investor to abandon their long-term strategy because their portfolio has lost value. The size of the stock portion of the portfolio will vary among investors. Everyone is different. But the key for long-term investors is to have patience with the inevitable market downturns and know that time is on your side.

Bonds

Traditionally, advisors and stock brokers have divided their clients’ portfolios between stocks and bonds. Stocks provided growth and bonds provided safety and income. This formula worked well for many decades when bond yields were higher. But today’s low-interest-rate environment has diminished the appeal of bonds as a source of income.

The 10-year Treasury bond currently yields around 1.5%. At the same time, inflation has spiked much higher. The Consumer Price Index (CPI) is up 5.3% over the last twelve months! Whether inflation will remain elevated is the subject of much debate, but as things stand now, investors in U.S. Treasury bonds are losing money in real terms. (i.e. The amount they are earning on their bonds is less than the rate of inflation.)

This is not to say that bonds are a bad investment. Bonds play a critical role in portfolio construction because they offer safety and liquidity. During times of market duress, high-quality bonds tend to hold their value (or even increase in value) and are easy to sell, as buyers seek the relative safety of high-quality bonds. This liquidity is important for investors that are drawing on their portfolio for ongoing living expenses. It is also important for portfolio managers like SilverPeak Wealth who will use the strength of bonds during times of financial crisis to buy undervalued assets like stocks when prices are low.

Real Estate

SilverPeak Wealth invests in real estate predominantly through diversified, public, non-traded real estate investment trusts (REITs). This is a mouthful, but the takeaway is that these are funds that own high-quality real estate properties. These funds are available to the public (not private), but are not traded on a public market like the stock exchange.

This structure has its advantages and disadvantages. The primary advantages are that they pay dividends in the 5%-6% range (distributed monthly), which are higher than most bond investments.

Secondly, because they are not traded on an exchange, the price-per-share is less volatile than publicly-traded REITs. And this share price is set through 3rd party appraisals of the real estate portfolio. This means investors can buy or sell at the fair market value of the underlying real estate. 

In addition to the attractive dividend and price stability, the income is typically not fully taxable. This is due to the favorable tax treatment afforded to real estate income under current tax law. Not to mention, investors can also see the value of their investment rise if the underlying real estate goes up in value.

The disadvantage of the non-traded structure is that these REITs can not be sold at a moment’s notice. These REIT investments do offer the ability for investors to sell their shares back to the REIT, but only during certain times (usually quarterly) and can limit shareholders ability to sell. For this reason, these REIT investments must be viewed as long-term investments, and not a place to earn higher income for a short period of time.

SilverPeak Wealth uses these real estate investments to fill a gap that stocks and bonds alone can not. That is, provide high current income with relatively low volatility. This is important to investors living off their portfolio income.

But even for investors who do not need the income, diversifying into real estate can still make sense as a way to mitigate stock market risk without giving up much in the way of  investment returns relative to stocks.

Conclusion

Investing involves risk of loss. Stocks, bonds and real estate all go down in value from time to time. But historically speaking, all these investment classes offer positive long-term returns, but at different scales and on different cycles. By combining these investment types in different proportions based on a client’s goals, we think we can achieve better long-term portfolio results with less stomach-churning volatility than the standard stock/bond portfolio used by so many other advisors.



Sign Up for the SilverPeak Wealth Newsletter!

» Market analysis and commentary from Hank Nicholson, CFP
» Actionable updates on important issues
» Actually receive valuable information in your inbox

SilverPeak Wealth values your privacy & adheres to a strict NO SPAM policy. Your information will never be sold, shared or used for any purpose other than SilverPeak Wealth.

SUBSCRIBE HERE