Faced with one crisis after another, investors need a new breed of resilient portfolio. How to find the right bunker.
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Michael Shlau had had enough. The Chicago commercial real estate lawyer watched lawmakers wrangle over the debt ceiling this summer, and as the deadline approached without a deal, he got nervous. So he buried his retirement money under the mattress. Figuratively, that is: Shlau, 38, moved his and his wife's 401(k) balances completely to cash. "It seemed silly not to step aside and let it pass," he says.
Shlau's decision — which, of course, helped him avoid the market's subsequent sound and fury — might have been extreme. But at a time when many investors feel their confidence beginning to buckle, he's by no means alone in his concern. If it's not the debt problems here, it's the debt problems in Europe. If it's not Europe, it's our own struggling economy. And if it's not our economy, well, those talking heads will just make up a reason, it seems. (The NBA is having a lockout — sell everything!) Confidence in the U.S. economy, according to a Gallup poll, fell this summer to a level not seen since March 2009. "People have forgotten how to be optimistic," says Jeanie Wyatt, a financial adviser in San Antonio, Texas. But downbeat or not, advisers say, savvy investors are nevertheless figuring out how to create a resilient portfolio.
The change starts with asset allocation. Yes, we all know that stocks and bonds — with Treasurys being a big exception — tanked together during the financial crisis. (Treasurys mostly held their own during the big fall in early August, too.) But advisers stress that spreading money among many different types of investments is still a good defense against wild swings in one market or another. For true diversification, it's important to go beyond stocks and bonds, these experts say. Some recommend keeping around 15 percent of your portfolio in so-called alternative investments that are less likely to move in lockstep with regular stocks and bonds. These include mutual funds that replicate hedge fund strategies such as shorting (betting against an individual stock or the broader market) and arbitrage (profiting from the difference between the sale and purchase prices of an asset). This alternatives bucket also includes commodities. Those who think gold is too pricey can buy mining stocks instead. Wyatt likes BHP Billiton, an Australian firm that mines gold, copper and other natural resources.
Proponents say alternatives can not only reduce a portfolio's ups and downs but also offer better growth prospects. When it comes to stocks and bonds, "you've got to ratchet down your return expectations," because they likely won't perform as well over the next 30 years as they have over the past 30, says Rob Arnott, chairman and chief executive of investment strategy firm Research Affiliates. Precious metals funds, for example, beat large-cap-growth stock funds by 11.3 percentage points a year over the past five years.
Investors also need to mix it up within each asset segment, experts say. Americans still have a home-team bias in their stock and bond selection; IRA accounts had 43 percent in U.S. stock funds and 14 percent in foreign stock funds as of the first quarter of this year, according to the Investment Company Institute. Many advisers say the foreign component needs to be higher. Countries such as Brazil and Indonesia are growing at a faster clip than the U.S., and their younger populations and abundant natural resources bode well for future growth, the pros say. In contrast, the U.S. is mired in debt, and spending cuts out of Washington could hurt firms along with stock returns, Arnott says. Many foreign governments also pay higher yields on the bonds they issue.
Diversification helps build on a portfolio's defense as well, which includes adding dividend-paying stocks. Dividends act like an anchor, says Howard Silverblatt, senior index analyst at Standard & Poor's. In good times, these stocks tend not to fly as high as, say, the hot tech stock of the moment, but they don't fall as far in bad times either. Kevin Kautzmann, an independent financial planner in New York City, says many
of his clients are wary of the markets and prefer to stick with conservative investments. "You don't want the money to be in cash, but where do you put it?" he asks — before answering his own question: Kautzmann likes dividend payers Philip Morris International and McDonald's, among other stalwarts. Intel, for instance, recently traded at less than 10 times expected profits and had a 4 percent dividend yield. Some bond investors are also gravitating toward blue-chip steady Eddies. As the debt-ceiling crisis escalated over the summer, Wilmer Stith, portfolio manager of the $114 million MTB Intermediate-Term Bond fund, began shifting his portfolio out of bonds of some banks and into bonds of companies like IBM. "If the worst scenario does play out, money has to go somewhere," Stith says.
But perhaps the best strategy for fearful investors is to take a hard look at their so-called time horizon, says James J. Angel, associate professor of finance at Georgetown University's McDonough School of Business. If they don't need their money for a while, they can take more risks. As for people with near-term income needs — like having to soon pay for a child's college education — they'll likely do best keeping that money in a guaranteed vehicle like a CD rather than in stocks, regardless of the market's outlook. "If you're really worried about what happens next year," Angel says, "you've got too much exposure to the market."
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