March 2, 2010, 5:00 am

How To Bulletproof Your Portfolio

by: The Financial Blogger    Category: Investment, Market and Risk
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Guest post by By The Rat

Biography For The Rat

The Rat is a young Canadian investor and entrepreneur hailing from the east coast.

After earning a Bachelor of Commerce in the Maritime Provinces, he returned home at the age of 21 to work in various capacities, most of which were in the private sector. There, he had the opportunity to accumulate over ten years of business experience in a range of senior management levels, take advantage of real estate opportunities, and invest in equities and other types of investment vehicles. In January 2010, he was able to retire and hence “end the rat race” in his early 30’s.

Going by the pen name ‘The Rat’, the author has etched out and created a small place in cyberspace through his website “Ending The Rat Race” with the intent to provide value to readers both in terms of content and sharing of real-life experiences.

Officially launched in September 2008, Ending The Rat Race is a personal finance blog that has as one of its key purposes, the sharing of various personal finance topics with others having similar interests, and learning from one another.

Do you know that if you had 100% of your portfolio into equities during the financial collapse, or more specifically during the periods of June 2008 to February 2009, you could have lost upwards to 43% of portfolio value?

How many people do you know or talked to during the financial crisis that mentioned they had lost almost half of their portfolio value, in a time frame that felt as though it was overnight? I have definitely heard a few of these real-life stories, and at the same time I have also learned from some of my own, costly mistakes to say the least.

For example, I have had discussions with people who were invested primarily in mutual funds, and because they took the advice to invest in a ‘well-balanced’ collection of funds, each of which were primarily invested in a basket of equities, were ‘hung out to dry’ during the market meltdown.

We didn’t have to go far to hear the horror stories. One of my previous threads, discusses a family (the Rossis) who were featured in a November 2009 MoneySense article titled, “From Rich To Ruin” and had lost over 40% of the value of their $314,0000 RRSP nest egg. This is an example of a ‘nightmare on wheels-type story’ where their adviser selected their funds for them. During the interview, one of the family members mentioned, “I would have been happier had we buried our money in a mason jar in the backyard”. This type of comment really hits home.

Some may say that despite the above mentioned, markets have recovered rather nicely since the financial collapse and that had the Rossis or others not panicked, the value of their respective portfolios would have likely rebounded quite nicely by now. Perhaps this is true to some extent, but not everybody has the same risk tolerance. I know that if I had kids and a family under a roof and all of a sudden I was forced to witness losses in the tens of thousands of dollars in a very short period of time, I would have been worried.

The interesting statistic I referred to in the opening paragraph stems from a November 2009 MoneySense magazine article, written by Suzane Abboud.  Adequately titled, “Better Crisis Next Time”, Suzane Abboud clearly demonstrates the importance of asset allocation in an investor’s portfolio and that sometimes a “do-it-yourself strategy” without all the fees may be a better approach to managing one’s portfolio. Even though the example I provided at the beginning of this thread falls under one of Abboud’s worst cases, it does highlight the fact that even typical balanced funds, which “holds more than 50% of its portfolio in bonds and cash” still experienced an “average loss of 23.5%” because of all the management fees and the fact that these investors had not taken a do-it-yourself approach.

In my view, what is really important to highlight from Abboud’s finding is her ‘take-no-prisoners’ approach to being clear and concise as it relates to the whole experience of the market meltdown. For example, she states, “Your experience during the recent market turmoil should determine your asset allocation going ahead. If you lost sleep, or couldn’t eat, at the very bottom of the bear market this past year, you should never put yourself in that position again.”

I believe the message that really stood out to me was when Abboud mentions, “If you want to make sure that your portfolio is not going to go down by more than 15%, you should not hold more than 40% of your money in stocks.”

As a result of the financial collapse and what I had witnessed within my own portfolio, I made some important changes. I had to look myself in the mirror and come to terms with the fact that 100% of my portfolio was in equities, and I had also been ‘chasing yields’ in the Oil & Gas sector with the thought of never-ending lucrative yields. One of my most important threads I ever posted, (despite its short length) was My Asset Allocation, mainly because I had reached a sense of realization as to how my investing strategy would be carried out on a go-forward basis.

My intent of this post is not to give readers the impression that “this is what you should do with your investments, and how you should go about doing it”. Instead, my purpose is to stress how important it is for investors to be cognizant of the risks associated with having the wrong asset allocation. Now that the ‘dust has settled’ somewhat with respect to the markets, we quickly realize the importance of one’s asset allocation as the economy and markets take wide swings. It’s up to the individual investor to bulletproof their respective portfolio given their own risk tolerance and investment style – by choosing the right asset allocation, this can be accomplished.

If I had more ‘safety’ in my portfolio during the financial collapse, I’m sure I would have witnessed much less volatility and loss of portfolio value had I had a more effective asset allocation. Lessons learned indeed.

What about you? Have you changed your asset allocation as a result of the financial collapse? Are you comfortable with your current asset allocation?

image source: ieshraq

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I pulled 10% of mine into a cash savings account. I didn’t move anything else. I still have the same investments but haven’t contributed in over a year.

Partly out of recognizing/appreciating the problems in the banking sector in late 2007 but much more out of luck – I had recently sold out of small business and wanted to get some cash together for something new that never happened – I sold down about 20% of my portfolio and put it into cash. At some point in 2008 I got rid of everything that was heavily geared as well, which also helped (though my defensiveness hurt me on the rebound).

Until you get well into the high six figures, there’s a lot to be said for holding a slug of cash as a private investor as a very cheap way of adding stability to a portfolio. Chase rates by following the deals and you’ll make a few percent a year, and suffer 0 on that portion when the market tanks.

You’ll also have cash to redeploy on those bargains! Puts a happier spin on bear markets 🙂

Have you changed your asset allocation as a result of the financial collapse? Yes when the market is down get more aggressive.
Are you comfortable with your current asset allocation? You bet!

I appreciate the opportunity for the guest post; thanks once again.

A thanks to all who commented as well!

The Rat

During the market crash, I made the most money I ever have. In fact, I made more money in the markets than I did at my job. It might have been as much luck as skill, but the act of scraping together $15k and investing in stocks I knew well, allowed me to profit. The benefit to doing it yourself is not the lower fees, but rather the conviction of knowing why you own the investments you do. That way, you avoid giving them away for half-price (which I will be happy to buy again, during the next crash).

Yes, you need to ensure your asset allocation only fluctuates as much as you can stomach, but you need to balance that with enough growth to reach your goals. If you’re working and your income provides for your lifestyle, you can sustain a protracted downturn in the market without HAVING to sell investments. It’s in retirement that safety becomes REALLY important.

by: The Financial Blogger | March 3rd, 2010 (9:43 am)

@ The Rat,
you are welcome 😉 it’s a pleasure!

I’m 100% stocks in all my accounts. I used to trade stocks, now i am more on indexes as I don’t have much time to follow individual stocks…

I concentrate my effort in my biggest investment : my online company 😉

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