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Is Your Portfolio Ready for the Election? Thumbnail

Is Your Portfolio Ready for the Election?

Market Volatility Election Dividends

As if 2020 hasn’t been crazy enough, we have a big election to work through in less than a month. With two very different ideas about governing, it’s safe to assume that there will be some confusion leading up to, going through, and immediately following this election. And, where there’s confusion, there is usually market volatility.

That leads us to ask: Is your portfolio ready for the election?

Building a proper portfolio involves more than simply picking a few mutual funds and putting them on auto-pilot. It even goes beyond buying the latest tech stock that everybody says is a "must buy". While these things can give you some solid returns, at least in the short run, it puts your money at risk for a big downturn when things change. Believe it or not, there is some science and process that can be put into place to put together a portfolio that can weather the ups and downs of the stock market in a way that can help you sleep easy at night.

The first key is to understand your “risk tolerance”. That term means exactly what you might think: How comfortable are you with risk? In the case of investing, risk is defined as market volatility. So, we’re trying to understand how comfortable you are with market volatility. In order to do that, we ask our client’s to complete a “risk tolerance questionnaire”. It’s a short series of questions and scenarios, scientifically designed to identify your true comfort level with market volatility and assign it a numeric value. That numeric value falls into a 1 to 100 scale and will help us understand how conservative or aggressive your portfolio should be.

The second part of the process is to properly allocate your investment assets. That means we want to have a mix of investments that, based on history, should create a predictable level of gain or loss. The amount of gain or loss should fall within a range that fits the level of comfort that was identified by the investor’s risk tolerance. A landmark study from economists Eugene Fama and Kenneth French showed that the proper mix of investment assets had significantly more to do with a portfolio’s long-term success than buying and selling specific stocks at exactly the right time. So this part is very important.

There are several ways to ways to allocate your investment assets. The first step is to determine the proper mix of stocks and bonds, with the riskier stock investments acting as the engine for growth, while the steadier bond investments provide a level of stability. From there, you can get more specific about what stocks and bonds to buy and how those should be mixed.

The most common way to allocate the stock portion of a portfolio is based, primarily, on the size of the company. You may have heard the terms “large-cap” (companies with market capitalization greater than $10 billion), “mid-cap” (companies with market capitalization greater than $2 billion, but less than $10 billion) and “small-cap” (companies smaller than $2 billion in market capitalization). In a market cap-based allocation, the portfolio is built to control risk by putting certain percentages of the assets into each size-based group. But, there are other ways to control risk, some of which do an even better job.

At EVIA, we dig a little deeper and divide the portfolio into the 11 market sectors that are recognized in the S&P500. These sectors include technology, energy, healthcare, and so on. Each specific market sector is more likely to be similarly impacted by a particular bit of news, or different economic conditions, than companies that just happen to be of similar size. For example, Exxon Mobil and Coca-Cola, both large companies, are unlikely to be similarly impacted by a world-wide failure of the sugar crop. So, by dividing the assets among the different market sectors, we can exert greater control over the risk in a portfolio.

When you have a portfolio that has been designed with your risk tolerance (numeric score) in mind, it has been designed to go through a variety of ups and downs. There is a great deal of historical research that has gone into determining the likely outcomes of any number of situations and, while there may be an occasional outlier, you should be able to ride through almost any change that could cause movement in the markets. So, regardless of the outcome of this election, you should be ready to weather the storm.

If you would like to take a closer look at your current portfolio to make sure you’re ready, please give us a call to set up a meeting. Likewise, if you know somebody who could benefit from this kind of investing approach, please introduce us.

We always like to meet new people, especially if they are people like you!