HOW TO STOP THE 401K ROLLER COASTER

HOW TO STOP THE 401-K ROLLER COASTER

I used to love rollercoasters.  They were the first rides I gravitated to at an amusement park, but now they are the rides I shun.  Perhaps it’s age.  When I was young, I thrived on the thrill and the risk that rollercoaster’s provided – the feeling of my stomach in my throat as we fell 60 feet at 60 mph meant the ride had achieved its intended purpose.  Now, riding a rollercoaster doesn’t even interest me.  I walk to the other side of the amusement park.  When I was young I was willing to take risk because I didn’t perceive risk – I was invincible.  Now, several decades and four children later I calculate risk and measure my ability to withstand the high and lows.  As a Certified Financial Planner®, I can’t help but see the similarities with today’s equity markets.  How has your advisor managed the market roller coaster?  Or you, if you manage your own portfolio?

Those of you wondering how you can stay on this rollercoaster, I offer four ways to calm your fears on this equity ride and structure your portfolio to smooth the ride.

1. Add Bonds or Fixed Income to Your Portfolio.  Conventional wisdom is that when equities do poorly in market stress, bonds rally or stay stable.  They have low or negative correlation  to stocks  – a positive for reducing portfolio volatility.  They act as a stabilizer for the ride.  In addition to the low or negative correlation, they provide yield – income – which further enhances the stabilization effect.

2. Add Low Volatility Products to Your Portfolio.  Webster’s Dictionary defines volatility as “the tendency to change quickly and unpredictably.”  We would recommend finding these “low-vol” stocks and/or ETFs that  provide smoother returns. An example of low volatile stock grouping would be utilities.  They are less prone to economic cycles – I am going to pay my electric bill before I go out for a dinner in hard times.  I can withstand a month without a 5 Guys cheeseburger, but a month without lights would be difficult during the winter in Chicago. Other examples of low volatility stocks would be:  consumer staples, industrial stocks – and any other stocks whose businesses are not highly tied to the business cycle.  In addition to being low risk some of these stocks can also throw off a nice dividend adding income to your portfolio.  Academic research finds that these lower vol stocks can outperform the market over longer time periods because active portfolio manager’s tend to invest in riskier stocks to try and generate higher returns.  This leaves lower risk stocks under valued.  Let the active managers ride the highs and lows of the roller coaster. 

3. Add a Minimum Variance Strategy to Your Portfolio.  This strategy uses mathematical formulas and constraints to combine stocks to form a portfolio with lower volatility than the overall market.  Some of the stocks in the portfolio may have extreme volatility, while other stocks might have low volatility.  It is the relationship between the stocks that form the lower volatility characteristics of the portfolio.  The holdings in a Minimum Variance strategy will more closely resemble the overall market compared to a Low Vol strategy. It will still dampen the ups and downs of the roller coaster ride, but less so than the Low Volatility strategy. 

4. Use Products With Equity Exposure that Provide Caps and Floors. Another term for these strategies is “Defined Outcome” strategies. How do I do that?  There are strategies available that use options to provide downside protection.  One of the costs of this downside protection is they will, also, cap upside potential.  This strategy is used for those seeking market growth, but, also, want to manage their downside risk.  

The stock market was a roller coaster ride in 2018.  In September,  the market had registered a positive year to date return of 9.6%.  As of December 30th when I wrote this blog, it was down 7%. 

The rule on rollercoasters is to stay in your seat.  Since jumping off mid ride will only get me hurt, these strategies offer an alternative so I can stay seated and finish the ride. 

Since investing can be like a roller coaster ride ask yourself what kind of ride you like. 

Do you enjoy the sharp ups and downs of a high risk portfolio or are you nearing the time when you may desire a smoother ride which dampens the ups and downs of the roller coaster ride?  If you are part of the latter, this January as you open up your 2018 account statements study them a bit.  Does your portfolio consists of any of the above strategies?  Has your advisor mentioned these strategies? 

If they don’t – or you don’t understand exactly how your portfolio is constructed – give us a call at Fortune Financial Group or email me at cris@fortunefinancialgroup.com.  We will help you smooth the market’s ride so you are not thrown off the roller coaster and finish the ride safely.