NEW ORLEANS – Northwestern Mutual’s Emmett G. Dupas III and Dylan Hoon contributed the following:
Nine years into a bull market we find our memories of the great financial crisis, George Bush, and a decent Batman movie beginning to fade. Today’s politics may make us nostalgic, but as investors we should be happy, maybe even a bit ecstatic, about how events have played out. For those of us who were invested in 2008, memories may include one of horror, or if you weren’t around or decided to mentally block out the experience, markets globally fell more than 40 percent as noted by Standard and Poor’s data. Feelings of hopelessness and apprehension gripped investors around the world. Our 401(k)s, IRAs, investment accounts, and even money market funds didn’t seem safe. If you were an aggressive investor, you might have seen your balances cut in half from the highs of 2007. This isn’t a doom and gloom article, and we are not here to tell you things are going to turn bad – we have a completely different story.
Currently, we are sitting in one of the greatest bull markets in U.S. history. Since those 2008 lows the S&P has more than tripled. It seems like every day we’re reading about U.S. equity markets reaching new highs or new DOW records, and hopefully we are happy with how we have been invested. We would never argue for an individual investor to attempt market timing. Trying to read the economic tea leaves and predict what the future holds is a losing effort for most. For us to be successful as everyday investors we need to focus on proper diversification, risk management, and staying invested through different market cycles. The year 2008 is a great example of why we need stay invested through a complete market cycle, through the ups and through the downs; however, the focus of this piece is on risk management.
Risk management involves monitoring our retirement and investment accounts, keeping our portfolio risk aligned with our risk tolerance and investment objectives. Strong bull markets create a behavioral paradox for most investors. It takes a market downturn and a feeling of panic for investors to take an assessment of their investment risks, but strong bull markets require our attention, too. U.S. equity markets have done extremely well over the last nine years and through this outperformance process our equity allocations may have increased. The investor paradox is that the better equity markets perform, the more our portfolio risk increases.
Let’s look at an example of a typical 60/40 S&P 500/US Agg Bond portfolio which tracks the S&P 500 Index and a basket of U.S. bonds. This portfolio would be comprised of 60 percent equities and 40 percent bonds and if invested five years ago on June 1, 2012, has more than doubled. According to our research done in Morningstar, five years later if we haven’t rebalanced, that same portfolio now sits at a 71/29 allocation, which means 71 percent equities and 29 percent bonds. This scenario has been good for our account balances, but warrants our attention to risk management. Most of our downside portfolio risk is located in the equity portion of our allocations, so as your equity allocation has increased during this bull market so has your risk. Risk can be measured many ways, but we want to want to focus on drawdowns, or how your portfolio performs if equity markets start to decrease. If the S&P 500 were to pull back 20 percent from our current 71/29 portfolio, our equity portion would drop 14.2 percent. In that same negative 20 percent scenario, our 60/40 portfolio sees a 12 percent drawdown. It may not seem like a huge difference, but in compounding every percentage point counts. Periodically reviewing our allocation and focusing on risk management will keep our allocation aligned with our investment objectives.
If you haven’t done this in a while, we urge you to reevaluate the risk in your portfolio. Take a look at your retirement accounts and call your advisor to discuss your allocation and risk. Don’t wait for a panic in the market to address risk. It’s during bull markets and complacency that risk management becomes most important. Happy investing.
*The opinions expressed above are those of Emmett Dupas in this article. This material does not constitute investment advice and is not intended as an endorsement of any specific investment or security. Please remember that all investments carry some level of risk, including the potential loss of principal invested. Indexes and/ or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment. Diversification and strategic asset allocation do not assure profit or protect against loss.
Dylan Hoon is a registered representative of Northwestern Mutual Investment Services, LLC (NMIS) (securities), a subsidiary of NM, broker-dealer, member FINRA and SIPC. He is not a licensed insurance agent, registered investment adviser, or representative of a federal savings bank. He holds his Series 7 and Series 66 licenses.
