MAKING CENTS: Headlines continue to tempt investors

Today, there are still record numbers of investors with more than a nominal sum of cash on hand.

pic source: fullfinance.com

The last market downturn of the lost decade had badgered many into submission. Now, several years into a strong U.S. equity market recovery, cash investors are taking notice and slowly taking low yielding cash instruments and thinking about ways to invest and take some risk. Maybe it is the right posture for you to take, but how would you feel if the quarter after you took the leap of faith your investment was worth 10 percent less?

Just because the statistics show a double in the U.S. equity markets since the low points of only six years ago doesn’t mean that it was a straight line up. Many times in the past six years investors’ commitments were tested as short-term volatility in the negative direction eroded the value of that investment. This will happen again, so you better be prepared to deal with it or learn how to construct a portfolio that may assist with downside protection.

This is even more poignant for index followers whose goal is to mirror or match the performance of a given index with as little cost as possible. If you succeed in building a portfolio that indeed mirrors a particular index, that means you would, in theory, expect to capture all of the upside and all of the downside. This experience, therefore, will be judged based upon your entry point. If you bought the day before a 10 percent correction started, you’ll feel lousy. If you buy the day after a 10 percent correction ended, you’ll feel like a genius.

There are many theories on how to mitigate this, but the best way to start is to ask yourself two very important questions. First is how much do you need to earn on your portfolio to keep up with inflation and live your life in a manner to which you envision. If the answer is 0 to very little, then you may not even need to expose yourself to any volatility of downside. If the answer is something higher than you can safely earn in a guaranteed account, then you may be correct to seek higher returns for a portion of your savings.
 

From here, construct a portfolio that will limit your volatility and attempt to deliver the returns that you need. The portfolio may consist of traditional asset classes such as equities and fixed income instruments. But to reduce volatility, you may want to consider other asset classes such as real estate and categories where performance is not tied to, or correlated with your other choices. These un-correlated classes may go down when your traditional classes are rising or vice versa.

John P. Napolitano is CEO of U.S. Wealth Management in Braintree, Mass., and 2012 president of the Financial Planning Association of Massachusetts. He may be reached at jnap@uswealthmanagement.com or on Facebook as JohnPNapolitano and US Wealth

John Napolitano is a registered principal with and securities offered through LPL Financial. Member FINRA/SIPC. He can be reached at 781-849-9200.

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