So far, it’s been a tough year for investors. As of late August, major stock indices are down a fair bit and so are bonds. Globally balanced portfolios are lower by 10% to 15% year to date*. The common refrain in the financial media that I follow very closely is “uncertainty”. The talk is about how high-interest rates will go; how long will it take for inflation to come down; what will be the impact on the economy; how will that affect companies’ profits and therefore, their stock valuations.
How do I deal with all of this? I think there is always uncertainty. Even when we are in the middle of a booming economy and bull markets in stocks, things can change quickly. On any given day, we could wake up to events and circumstances that suddenly make markets fall or change the outlook for the economy. The sudden onset of a global pandemic in early 2020 and the effect it had on investments and the economy are great recent reminders of this. So the first thing I do to deal with uncertainty is to always be ready for anything.
Proper portfolio construction – and by this, I mean proper diversification – acknowledges that we don’t know what the future holds. Therefore, portfolios should not have strong biases. For example, they should not be heavily overweight in a specific part of the world or a particular sector of the economy. When you have a strong bias in your portfolio, you are saying that you know what will happen in the future.
When you diversify in a way that includes…
- different asset classes (stocks, bonds, real assets)
- different parts of the world (Canada, US, International, Emerging Markets)
- different sized companies (large, medium and small)
- different investment styles and philosophies (value, growth)
…you are positioning yourself with humility and acknowledging that you don’t know what the future holds. And as I’ve said before, humility is an advisor’s most important attribute.
If you are structured properly, you usually don’t have to do anything to your portfolio when the environment changes. If you have to make a major change in your holdings and in your strategy, you probably weren’t well positioned in the first place.
Determining the specific structure of a given client’s portfolio follows a lengthy discussion and often, the formulation of a comprehensive financial plan. This helps me to understand their unique needs and circumstances. By doing this, we don’t get caught flat-footed and unprepared for a sudden turn in markets. For example, if that portfolio pre-construction analysis uncovers that they will need money for some purpose in the near term, that money will be set aside and kept out of investments that can suddenly drop in value.
Dealing with uncertainty starts the day I meet the client and never stops. It’s not something that comes around like the seasons. It’s the world I live in 365 days of the year.
*Based on the median year-to-date return as of August 31, 2022, of Global Neutral Balanced F Class funds as published by Morningstar