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The Antidote To Fear And Greed: Risk Management

What does last week’s market slide across most of the major asset classes imply for investing? A lot…or maybe nothing. The decision to adjust a portfolio, or not, depends on the risk-management strategy. Every portfolio needs a clear-eyed plan for dealing with risk – it’s the financial brain that controls the investment body and provides the map for navigating rough financial seas. With that in mind, now’s a good time to review and reaffirm the first principles of enlightened risk management in the care and feeding of conventional investment portfolios. 1. Develop a plan. Yes, that’s obvious, but it’s easily overlooked. Many investors have a general appreciation of the merits for managing risk (as opposed to chasing return) but don’t have a proper plan in place. Vague notions of what you may or may not do don’t pass muster. You needn’t be a slave to rules, but there should be a clear path for traversing periods of chaos as well as calm through time. This includes a methodology for regularly collecting and analyzing relevant data that’s integral to your plan. 2. Recognize that a successful risk-management strategy will be multi-faceted. There are no simple solutions or silver bullets. Instead, there’s a zoo of possibility in terms of risk factors from which you’ll selectively choose for assembling a customized plan. That said, there are two concepts that typically form the backbone of risk management: asset allocation and rebalancing. 3. Notice the limits of asset allocation. Like any one aspect of risk management, this one has flaws. This implies that you should add techniques that compliment AA’s deficiencies. 4. Choose weights for asset allocation that match your goals and risk profile. For what should be obvious reasons, there are no one-size-fits-all solutions here. But there’s an obvious place to start: market-value weights, which offer useful reference points on the customizing journey. 5. Rebalance. Plan on adjusting the portfolio mix on a periodic basis. The details will vary, depending on your specific goals, expectations, and other factors. Unless you’re an institution with an effective time horizon that’s infinite, embrace the practical reality that every allocation requires oversight and tweaking. 6. Design rebalancing rules that are appropriate for you. Any number of inputs will inform your choice. For instance, how much drawdown can you tolerate? Every portfolio needs to be rebalanced on a periodic basis. The details on how and when offer the potential for greatness-and trouble. Proceed cautiously. The standard strategy: systematically return the portfolio to the target weights every year or two. The crucial question: Should you instead deploy an opportunistic plan based on monitoring a set of tactical signals? If so, note the following: 7. Juicing the standard rebalancing rules by adding tactical components to the risk-management plan – integrating moving averages, factors such as value and momentum, etc. into the rebalancing rules – can be productive. But careful planning and oversight are essential. Given the zero-sum reality of markets with respect to benchmark-beating results, most efforts on this front will deliver mediocrity or worse, particularly for return-boosting efforts on an after-tax/cost basis. By contrast, lowering risk is a more reasonable expectation. In either case, a fair amount of R&D is critical. 8. Manage expectations. No risk management plan is perfect and so there will be times when results are disappointing. Meanwhile, align your expectations with the target outcome of your risk-management techniques. A strategy that’s focused on limiting the downside, for instance, may look unimpressive before adjusting for risk.

What I Do When The Market Tumbles

When stocks take a dive, investors call their financial advisors and ask them what they should do. I received a few of those calls this week. Most advisors respond with some version of “Don’t panic.” Here’s what I do when the market crashes: nothing. To be completely honest, I wasn’t aware that the market had fallen 8% so far in January until my wife told me late this week. I don’t watch business news – life is too short. She picked it up on CNN while she was watching election news. (I don’t follow that, either.) Here’s my theory. If you have such a high allocation to equities that market declines make you anxious, you own too much stock. Find the allocation at which severe bear market losses won’t keep you up at night. In the 2007-2009 bear market, the S&P 500 fell over 50%. My portfolio fell just 15% because I had a 40% equity allocation. As one of my favorite baristas, Mandy, would say, “It didn’t feel totally awesome.” On the other hand, I didn’t lose sleep. William Bernstein addressed this in a couple of his early books, including The Four Pillars of Investing (page 268). He suggests that the initial pass at the correct asset allocation for you be based on how much you can tolerate losing in a bear market. He provided the following table: I can tolerate losing this percent in a bear market Invest this much in stocks 35% 80% 30% 70% 25% 60% 20% 50% 15% 40% 10% 30% 5% 20% 0% 10% Every December I evaluate my finances and plan for the coming year. I calculate my desired asset allocation, which might not be the same as last year’s. If my current allocation is within an absolute 5% or so of my desired allocation, I do nothing. Otherwise, I may trade a few funds or ETFs to implement my new allocation. In reality, this rarely happens because my allocation doesn’t often stray very far. Because I am willing to lose 15% in a severe bear market, I don’t labor over my portfolio value daily. I probably check it four times a year, at most. I retired to enjoy the remainder of my life, not to fret over the stock market. Here’s some advice from other advisors I trust. Wade Pfau suggests reading this piece in the New York Times entitled, ” 6 Tips for Investors When the Stock Market Tumbles. ” It’s a good one. Dana Anspach suggests that if you feel that you must do something, instead of selling stocks, enroll in her free online class on retirement – another great idea. Joe Tomlinson and I provided suggestions in Robert Powell’s USA Today column, ” Advice for investors during crazy stock market volatility .” If you’re retired or plan to be soon, set your asset allocation to a level of equities that you can tolerate. By definition, that means you won’t feel the need to do anything at all when stocks tumble. For young people still accumulating savings for retirement, invest most of your portfolio in stocks and don’t you do anything, either. In fact, do less than nothing. Time will fix this for you. As I recall, the 22% loss on a single day on Black Monday in 1987 didn’t feel totally awesome, either, but now it is barely a blip on the history of the S&P 500. So, here’s my advice: pick an allocation you can stomach and ignore the noise. If you owned too much equity this time, gradually adjust it downward. You’ll know you’re at the right allocation when the market takes a dive and you don’t feel a need to call me. Oh, and don’t panic.

Can Grain ETFs Sustain The Recent Rally?

Taking the market by surprise, grain prices and the related investments popped lately. This is perhaps the sole good news in the investing world to start 2016 as the broader market has seen choppy trading so far. And as far as commodities are concerned, nobody knows when and where their prolonged rout will end. Lower estimates for U.S. crops showered these unexpected gains on grains. Lately, USDA reduced its numbers for the 2015 corn and soybean harvests and sharply cut winter wheat planted acreage to 36.61 million acres, which was “the smallest winter crop in six years.” The figure exceeded analysts’ expectation of a decline of 141,000 acres. Per USDA, corn harvest is presently at 13.6 billion bushels, lower than USDA’s December reading of 13.654 billion. The soybean produce was recorded at 3.93 billion while USDA’s latest reading was similar to the 2014 levels. While many agricultural commodities advanced, wheat prices soared the most in two months. As a result, the Teucrium Wheat ETF (NYSEARCA: WEAT ) , the iPath DJ-UBS Grains Total Return Sub-Index ETN (NYSEARCA: JJG ) , the Teucrium Soybean Fund (NYSEARCA: SOYB ) and the Teucrium Corn ETF (NYSEARCA: CORN ) added about 2.1%, 1.8%, 1.4% and 1%, respectively, on January 12 (read: Invest in America with These 4 ETFs ). Can the Positive Momentum Sustain? Per Bloomberg, while U.S. output may moderate, global supplies of wheat remain ample thanks to solid output in Russia, Pakistan and the European Union. On the other hand, the demand scenario is as sluggish as it has been in recent times. Global growth worries mainly in most of the developed economies and in some emerging economies too resulted in softer demand for food. USDA also pointed to this issue with “a small reduction in domestic usage and a cut to exports.” USDA lowered the export numbers for corn and soybean to 1.7 billion bushels from its previous 1.75 billion and to 1.69 billion from 1.715 billion, respectively. Still, there are a few agro-based products which could deliver decent gains to investors despite the broad-based gloom. Below we highlight those products in detail (read: 3 Commodity ETFs Defying Weakness in 2015 ). iPath Dow Jones-UBS Sugar Total Return Sub-Index ETN (NYSEARCA: SGG ) The sugar prices are expected to remain steady though most of the other commodities are finding the going tough. This is because; supply glut is an easing issue in the global market due to adverse weather. SGG tracks the Dow Jones-UBS Sugar Subindex Total Return Index, which provides returns that are in an investment in the futures contracts on the commodity of sugar. The note has garnered nearly $53.2 million in assets. It charges 75 bps in annual fees. The note was up 1.1% in the last five days (as of January 13, 2016). iPath Dow Jones-UBS Cotton Total Return Sub-Index ETN (BAL Notably, cotton price is also showing hopes on higher purchase from the spinners and exporters. Also, in India, a key grower of cotton, the central government’s move to intervene in the pricing of cotton might help in shoring up the commodity. The product has amassed about $17 million in assets and charges 75 bps in fees. BAL gained 1% in the last five days (as of January 13, 2015). iPath Dow Jones-UBS Softs Total Return Sub-Index ETN (NYSEARCA: JJS ) The note looks to provide the returns that are available through an investment in the futures contracts on the softs sector of the commodity world. Components currently include sugar, coffee, and cotton. This $2.6-million ETF charges 75 bps in fees. Though the product lost 2% in the last five days, it added about 1.5% on January 13. Link to the original article on Zacks.com