Most people only want to look at the upside. How much money can I make? How big of a return can I get? Big wins are important.
Few people ask, “How much can I lose?”
You should always play offense and defense with your portfolio.
The basic concept behind asset allocation is based on this. Using some combination of assets – stocks, bonds, REITs, etc. – smooths out the ride over time so you don’t get squashed when one asset falls sharply.
The AA portfolio in the asset class table helps to visualize this concept. But it only works if you’re willing to miss out on some gains because one asset class rose sharply.
It’s the missing out that gets people in trouble. Deviating your portfolio in the hopes of greater gains, adds to the risk you’re already taking. Most likely, it’s more risk than you’re comfortable taking.
So you have two options:
- Either, you stick with one allocation rebalanced fairly often. Regardless of what the market is doing, your allocation doesn’t change.
- Or you adjust your portfolio opposite of the mindset in the markets. When the can’t lose attitude surfaces, it’s time to be defensive. When the can’t win mentality rises, it’s time to be offensive.
Both choices have good and bad points. There is no right option. What matters is you pick one and stick with it.
I lean toward the second only because the riskiness of an asset is never static. Too often, we view assets from a binary perspective. Stocks are risky. Bonds are less so.
In reality, risk is fluid. Stocks are much less risky after a crash than before it. And there are times when bonds are more risky than stocks. An allocation should allow for flexibility, based on a set of rules, as risks change.
The most important thing that an investors has to do, at a point in time, is to set the balance in his portfolio between offense and defense. Not stocks versus bonds, U.S. versus foreign, large cap versus small, securities versus hard assets. Offense versus defense…I think you have to balance the two. And I think you have to favor caution. ~ Howard Marks on CNBC
A football analogy might be too obvious, but you never see the offensive juggernaut win the Superbowl without a great defense behind it. Most championship teams are balanced on both sides of the ball (probably with a slight skew toward defense).
- Are You Ready for the Next Bear Market? – J. Brown
- Selling is the Easy Part – A Wealth of Common Sense
- The Trick to Making Better Forecasts – J. Zweig
- Tyranny of the Calendar – M. Housel
- And Now Let Us Remember the Worst Economic Prediction Ever – Wonkblog
- Are Buybacks an Oasis or a Mirage? – Research Affiliates
- Beer before Steel: Ranking 30 Industries by Fundamental Equity Performance, 1933 to 2015 – Philosophical Economics
- Trade Secrets From Two Investing Legends – Daily Reckoning
- The ‘Hot Hand’ Debate Gets Flipped on Its Head – WSJ
- Crisis Chronicles: Defensive Suspension and the Panic of 1857 – N.Y. Fed