Asset Allocation: A Foundation of Prudent Investing

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Spring 2013

Asset allocation and diversification are often considered to be the foundation of prudent investing. Yet when dramatic market fluctuations occur, it’s easy to make impulsive changes that don’t align with long-term goals.


“Bull and bear markets can be emotional roller coasters,” says Rob Haworth, our Senior Investment Strategist. “But your long-term plan is there for a purpose, and it is our job to help our clients stay the course.” However, it is important to consider adapting your asset allocation to market shifts. Work with your portfolio manager to make strategic decisions that may help you meet your goals while maintaining an acceptable level of risk. Consider these five steps we believe are necessary for effective asset allocation.


Step 1: Set Strategic Goals

The first step in planning your asset allocation and diversification is defining your long-term financial goals — saving a specific amount by a certain age or creating an income stream that will last 20 years, for example — then creating an investment strategy to work toward those goals. “You need to have a goal so you can evaluate whether your portfolio is working for you,” says Clay Webb, our Head of Asset Allocation.

Photo by Tony Anderson


Setting goals can potentially help you avoid impulsive decisions in reaction to a volatile market. “Without a clear goal, it’s easy to get frustrated by how assets are allocated during a bad year,” Webb says. “If the market is excessively strong or weak, investors often want to push back on their plan. But it’s important to remember what you are trying to accomplish in the long term.”


From there, your portfolio manager can help you identify an appropriate balance of assets for your investment objectives and determine your acceptable level of risk. For example, someone with $5 million to invest over 20 years may be willing to withstand more volatility than someone with the same amount but who needs it to generate an annual income, Webb says. 

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Spring 2013

Assets chosen should be diversified and uncorrelated — and therefore less likely to rise and fall in sync. This may mean introducing new asset classes or selecting investments across an array of markets and industries. Keep in mind that new asset classes or investments come with their own risk factors.


“A properly diversified portfolio can help reduce overall market risk,” says Bob Webster, National Director of Wealth Planning for The Private Client Reserve. “Gains in one investment class may help offset losses in another.” 


Step 2: Consider International Stock

One strategy to help achieve portfolio diversification is through international stocks from both emerging and developed nations. “International stocks provide different characteristics and different volatility in terms of currency and economic conditions,” Haworth says. 


Yet many investors today shy away from international stocks, particularly those from the European Union because of the current volatile economic conditions there. While that’s anunderstandable concern, it’s not justification to ignore the entire international market as an asset class. International market fluctuationshistorically have had a low correlation to the U.S. market and may add balance in terms of currency value, Haworth says.

Plus, international investments offer a range of options that spans the risk scale. They do come with their own risks, though, such as foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments.


Step 3: Make Tactical Moves

Once your diversified portfolio is in place, you can work with your portfolio manager to make adjustments within your specified guidelines in response to market fluctuations. 


If, for instance, the market becomes excessively volatile or interest rates rise, you may opt for changes within the bandwidth of the predefined ratio of asset classes to potentially maximize wealth or minimize risk. Or, to potentially minimize the impact of investment taxes, you may increase tax-exempt investments and decrease other income-producing investments. 


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“Such tactical moves may enhance the after-tax portfolio value, and you could possibly add an additional amount of return per year simply by rebalancing,” Haworth says. The Private Client Reserve portfolio managers track these near-term market fluctuations and may be able to advise you on thoughtfully repositioning your portfolio in response.

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Spring 2013

“It helps to have someone by your side who can calmly put things in perspective and make sure you stay the course,” Webb says. “Even experienced investors can let their emotions get in the way of prudent investment decisions when they manage their own money.”


Step 4: Perform Periodic Reviews


Along with tactical adjustments, investors should review their strategic portfolio goals with their portfolio manager once or twice a year to determine if they are in line with their target objectives, and if those objectives have changed. “If your goal was to double your money in 10 years, and you accomplished that goal in five, you may want to re-evaluate how to position your portfolio for the remaining years,” Webb says.


Conversely, if you are nearing retirement and your portfolio isn’t worth what you had hoped, you may consider adjusting your risk tolerance. “You always need to look at your investment through the lens of your objectives,”
he says.


During these cyclical reviews, Webster suggests conducting a cash flow analysis to see if the portfolio is on pace, as well as a Monte Carlo simulation to assess the likelihood that the portfolio will achieve its ultimate target goal. A Monte Carlo simulation projects cash flows, networth and net heirs values multiple times, each under a different set of conditions,

to yield a range of possible outcomes. The results produce the probability of achieving different outcomes. If the Monte Carlo analysis points to a less than 80 percent likelihood of success, you may want to adjust your goals or risk tolerance, he says. 


"If the market is excessively strong or weak, investors often want to push back on their plan. But it’s important to remember what you are trying to accomplish in the long term."

— Clay Webb


Step 5: Stay the Course with a Trusted Advisor

As you look at the current volatile marketplace and think about your long-term financial ambitions, remember that investing is not about choosing the top-performing asset class. “It’s about how you combine asset classes to create predictable value over time,” Haworth says.


A knowledgeable advisor can help you make portfolio-balancing decisions and stay focused on the end goal to avoid impulsive choices that may expose you to unnecessary risk. 


The Private Client Reserve portfolio managers are available to help you make the choices that can support the achievement of your goals.


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