Most investors are aware of the importance of diversification across traditional investment asset classes, such as stocks, bonds and cash. We also understand that the stock market has historically moved in cycles over many decades.
Take the last few decades for the Dow Jones Industrial Average, which include extended bull markets when market values are rising, as well as long bearish stretches where markets move sideways or fall. Over the last 12 years (2000 to 2011), the cumulative return for the Dow was less than 12 percent, in contrast to the preceding 17-year bull market (1982 to 1999) where the Dow posted an astounding 1,003 percent cumulative return.
There’s a limit to what we can glean from those figures, but there’s one obvious lesson (especially if you think the market’s future looks more likely to reflect a continuation its recent results): Returns are unpredictable, and you might want to consider building a long-term investing strategy that includes managing risk as much as your return. That means diversifying even more.
By combining traditional asset classes with alternative investment options, like managed futures, commodities and others, as well as strategies centered on risk management and tactical management, there is a potential to increase returns and lower volatility.
It’s the sort of thing that university endowments do now, with some success. As reported by the NACUBO-Commonfund Study of Endowment Results, over the last decade, the Standard & Poor’s 500 index returned a modest 2.7 percent, while 472 university endowments of all sizes consistently outperformed the index. Interestingly, endowments with the greatest exposure to alternative assets performed the best, with average annual yields of 6.9 percent.
The goal is to grow your portfolio, so market exposure is an important consideration. The next step is to bring together investment strategies and options that help manage risk and keep you invested during uncertain times. Traditional investments tend to move in tandem during times of volatility which makes building a diversified portfolio a greater challenge. Portfolios that have included alternative investments have historically been associated with less correlation to traditional investments. This means they may perform differently under the same market conditions and can potentially provide further diversification, lower portfolio volatility, and potentially increase returns.
To address market unpredictability and volatility, risk management strategies seek to systematically reduce risk exposure when markets trend downward and increase exposure when market trend upward. Strategic allocation and tactical management may provide greater flexibility and responsiveness to the dynamics of the market, that seek to identify trends, risks and opportunities over time—and through business cycles.
Dean J. Catino, CFP®, CPRC, is a Managing Director and co-founder of Alexandria, VA-based Monument Wealth Management, a full service wealth management firm located in the Washington, DC area. Dean and the rest of the Monument Wealth Management team can be followed on their blog at "Off The Wall", on Twitter @MonumentWealth, and on their Facebook page.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Monument Advisory Group, LLC, a Registered Investment Advisor. Monument Advisory Group, LLC, and Monument Wealth Management are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Alternative investments may not be suitable for all investors and involve special risks such as leveraging the investment, potential adverse market forces, regulatory changes and potentially illiquidity. The strategies employed in the management of alternative investments may accelerate the velocity of potential losses. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Asset allocation does not ensure a profit or protect against a loss. Tactical allocation may involve more frequent buying and selling of assets and will tend to general higher transaction cost. Investors should consider the tax consequences of moving positions more frequently.