Joel Dresang: Kyle, occasionally we have news events that really disrupt the financial markets, cause a lot of volatility. The Greek debt crisis a few years ago, the federal government shutdown in 2013, more recently, the British vote to leave the European Union. But your point is that if you’ve got a properly allocated portfolio, you don’t have to worry about those things. Talk about that.
Kyle Tetting: There is no shortage of concern out there. There’s always going to be something on the horizon to worry about, but I think it’s incredibly important for investors to remember that when you look at the way we build portfolios from the top down, we’re planning for those kinds of events.
So you look specifically at kind of a traditional 60/40 stock/bond portfolio. For an investor that’s taking out 4% of their portfolio a year, it has got 10 years’ worth of income – that’s 40% – in safer money in things like bonds.
Joel: So, as you said, you build from the top down to make a portfolio that’s protected for the downside. What about from the bottom up? You also look at the individual investments within that portfolio.
Kyle: Absolutely, Joel. I think a big piece of the puzzle is trying to make sure that we put together investments that work in different ways at different times. So you look at not just the relationship between stocks and bonds, which tend to move in the opposite direction, but you also look at the relationship between other asset classes that we might bring into that portfolio – and the individual investments that make that up.
Joel: You have tools for testing how those different investments will work.
Kyle: Yes, we certainly do. I think one of the best tools out there, just to get an overall sense of how volatile a specific investment is, is to look at its beta – or its risk relative to the benchmark. So, how much is that investment going to bounce around when, for example, the S&P 500 is bouncing around?
But more importantly, we also have some tools that measure how much an investment is going to bounce around specifically when its benchmark is down. So we have things like downside capture, which looks at how much participation does an investment have in the downside of the market?
We have things like bear market rank, which tell us how does an investment do in bear markets, and how does it do relative to its peers? To get an idea not just of how volatile an investment is, but what kind of protection do we have when things go sour?
Joel: So you can structure the portfolio to protect on the downside and have ways of testing the individual investments within it. That all sounds very rational, but we don’t always feel rational about how our investments are doing.
Kyle: There is a ton of irrationality out there. You look at investors concerned about what that next market event might be. I think it’s so important to remember, first and foremost, that the way we build portfolios – and what we put into those portfolios – is designed to navigate that risk. But to the extent that you’re still concerned, to the extent that an investor still has some fear about what might be on the horizon, a great time to take stock of your portfolio and potentially make some changes, if necessary, in response to those concerns.
Not in response to what’s happening in the market, but in response to what the investor’s individual concerns are.
Kyle Tetting is director of research at Landaas & Company.
Joel Dresang is vice president-communications at Landaas & Company.
Money Talk Video by Peter May and Jason Scuglik
(initially posted July 28, 2016)
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