Invesra, Invest in your Future

Negative news is always the loudest

The recent negative economic news and market uncertainty is on center stage right now. Information overload hits you day after day. Noisy data: The Fed lowering or raising interest rates, the very weak dollar, oil and other commodity prices rising, food prices jumping, food shortages, weak GDP, inflation rising, employment weakening, climate change, a Democrat or Republican as next President, not to mention climate change. All this noise can be harmful to your investment well being.

When that news is at its loudest, you may think you need to take action. The worst thing to do is to give in to that urge to make major changes to your portfolio, particularly if you have a long term horizon for those funds, such as 20 or more years.

Why reacting to this noise is not a good idea

If you change your asset mix based on what is happening today, when will you know to tinker again? What noise will trigger another change? The situation as it exists today will change and change again. You may find yourself asking yourself and others what you should do next . Assuming your portfolio is diversified within and across asset classes, there are two questions to ask: 1. Am I taking on unintended risks within my equity and bond funds? and 2. Does my asset allocation between stocks and bonds still make sense?

Your stock portfolio: are you as well diversified as you think you are?

Stocks have the highest potential for losses. Market risk is always there. The second type of risk is sector and stock risk. The more weight that is placed in a particular industry sector, the more “active” risk you are assuming relative to the inherent risks from the market. If you own a collection of actively managed equity funds, you need to look beyond the names of the funds to understand the risks that you are taking. For example, by looking at the underlying holdings and combining all the holdings of your funds as one portfolio, you might uncover unintended sector bets such as an overweight to oil or financial stocks relative to the size of those two sectors of the market. Also, you might think you have exposure to the very largest U.S. companies only to learn that you are significantly underexposed to this market. To gain the most diversification within equities, a well structured portfolio of index funds can eliminate stock and sector risk relative to the overall markets.

All bonds are not equal

Not all bond funds are the same. Bond funds can invest in US Treasuries, corporate bonds, mortgage backed and asset-backed securites. As with stocks, these segments create different kinds of risk. All fixed income securities carry inflation risk as inflation erodes the buying power of the currency. Other risks are interest rate risk and credit risk. There is no risk to loss of capital with U.S. Treasuries since these are backed by the U.S. Government. Corporate bonds are more sensitive to economic activity and carry credit risk. Investors in corporate bonds get compensated for this additional risk in the form of a higher income yield. When looking at your bond funds, you should know how exposed you are to these various types of securities.

Risk in asset allocation

Asset allocation is simply about finding the right mix of assets that provide the appropriate level of risk and return for you. Although stocks provide potential gains, the risk of losses has greater importance when you are closer to retirement. Bonds carry the least upside and the least downside potential. If you incur a loss just as you begin drawing on your nest egg, your assets may not recover from the reduction in capital and may not last as long as you had hoped. To reduce the likelihood of this happening, you can create more certainty in your portfolio by increasing your allocation to bonds. It’s not a very exciting story but you will sleep better.

What is to be done about the noise?

Don’t let yourself be swayed by headlines and information overload. Just plug into your portable media device and tune it out.