Recently an acquaintance urged us to give more specific investment recommendations in this column. While tempting, it is difficult to be very specific since our investment advice is personalized for each person’s particular situation and we are limited by space for this column. We strive to explain our asset allocation process of designing a portfolio that achieves a specific purpose for each of our clients. As the old proverb states, “Give a man a fish; you have fed him for today. Teach a man to fish; and you have fed him for a lifetime.”
Hopefully, you already started with some clearly defined financial goals. Next, you start diversifying your assets into various asset classes – stocks, bonds, real estate, commodities, etc… Your goal is to minimize the risks of individual classes by balancing them with other asset classes that don’t share the same risks. To do this, investors traditionally look into the past to determine how each asset class behaved (their risk) in different economic environments and blend those together into a purpose-built portfolio. Unfortunately, if the future doesn’t look anything like the past, you have a real problem.
Our current economic environment has no historical analog. Domestically, the national debt and spending deficits are skyrocketing while unemployment and housing prices remain an obstacle to economic growth. If investors are looking in the rear-view mirror to determine what asset classes to invest, it may not work due to the unprecedented economic reality we are living in today. We expect economic growth to be much slower than any of the post recession periods in the past 50 years as we work off our massive personal and public debt. Does your portfolio reflect this reality or are you taking more risk without any significant potential for increased returns?
For months, our analysis pointed to signs the economy was decelerating, and we reduced our risks accordingly. While most of the financial headlines include our domestic debt ceiling debate, we now are focusing on the heated sovereign debt problems in Europe, which originated with small countries like Greece, Ireland and Portugal but have recently spread. Unlike Greece, Italy is the fourth largest economy in Europe. Like Greece, It is starting to display similar sovereign debt symptoms. Some analysts are optimistic our domestic deceleration is the temporary result of oil prices spiking and the economic disruptions in Japan; they are willing to speculate on a positive outcome. We would rather be a bit late on an economic recovery in an effort to avoid the risk of a double-dip recession. These uncertainties will become clearer in the next few months. Right or wrong this is our disciplined process of managing risk. It takes patience and a dose of humility to execute. What is your process?
