In spite of some rough days earlier this year and in recent weeks, with the run up in the
markets over the last couple of years, most people have been happy with their portfolio’
s performance. To what should they attribute this result? An old Wall Street adage is
appropriate at this time: “Don’t confuse intelligence with a bull market!” Your friends,
neighbors and acquaintances have probably been telling you how great they are doing.
And some may be doing significantly better than others. Some advisors and some
investors often start taking more risks when the market is doing well. During those times
it almost doesn’t matter what you’re invested in. Just being in the market makes people
successful.
While nearly all investment strategies work well in an up market, the true test for your
investment strategy is: how does it do in a down market, particularly when the market
drops 10% to 20% within a few days. You can get a sense for how you will do in a 20%
market decline by multiplying your equity holding percentage by 0.2. For example, if
your portfolio is 50% equity and 50% fixed income, a 20% downturn in stocks will result
in a 10% downturn in your portfolio, assuming all equity asset classes also decline by
20%. When the tech bubble burst a few years ago, Real Estate Investment Trusts
(REITs) and many small domestic stock funds actually increased in value, offsetting the
decline in international stocks and large stocks. If that occurred again, your portfolio’s
decline could be considerably less than 10%.
When times are good we are always tempted to try other approaches that “appear” to
be superior. Avoid trying to “time the market” and be cautious about new “sure fire”
investments that are “guaranteed” to return 15% or 20%. If a quoted return is very high,
you can bet that the associated risk of the investment is also high.
Diversification (as well as investing in well-managed, tax–efficient, low-cost mutual
funds), is the real key to surviving in down markets. Owning twenty different large U.S
stocks does not make your portfolio diversified. True diversification involves owning a
number of broad asset classes such as cash equivalents (money-market funds, short-
term CD’s and Treasury Bills), short-term bonds, intermediate-term bonds, international
and high-yield bonds, large domestic stocks, small domestic stocks, international stocks
and real estate equities. Some advisors include emerging market stocks and natural
resource equities, as well.
Keep in mind that the true test of an investment strategy is how it does in a down
market. If your portfolio is broadly diversified it will help minimize potential losses.
David C. Patterson, CFP® and Erin Patterson, CFP® are the owners of Patterson Advisors, LLC, a fee-
for-service-only financial advisory firm. Patterson Advisors, LLC is a Registered Investment Advisor,
registered with the State of Michigan, helping clients in Waterford, Clarkston and Royal Oak, Michigan
as well as other Oakland County, Michigan communities . Visit www.pattersonadvisorsllc.com for more
information or call 248-674-2108.
Published in The Oakland Press OurTown Online Clarkston, May 2007
& in the Oakland Insider, August 2007, Re-titled as: Down Market is true Test
Feeling Good? Most Investors Are!
By David and Erin Patterson