By Emmett Wright, CFA
Chief Investment Officer
Northwestern Mutual Wealth Management Company
When the patriot Thomas Paine famously wrote in 1776 that “These are the times that try men’s souls,” he could as easily have been talking about the current market environment.
Roiled by recession, a global credit freeze, rising unemployment, and bankruptcies, the U.S. stock market, as measured by the Standard & Poor’s 500 Index, suffered a decline of 37% percent in 2008, the worst calendar year since 1931 (when the index lost 43.3%). The result is that millions of Americans now find themselves far behind financially where they thought they’d be.
What’s next? What can investors do to put their financial goals back on track?
While current events clearly challenge the mettle of even the most experienced investors, one thing is certain: the key to long-term investment success hasn’t changed. Asset allocation and diversification still have the power to help investors weather uncertain market conditions.
Asset allocation is one of the most important building blocks of a sound investment strategy. In fact, studies have found that how you spread your money among equity and fixed income investments has far more impact on your results than any other investment decision. Past performance, stock selection and timing investments were far less influential in achieving long-term results.
The reason asset allocation works is simple: like pistons in an engine, stock, bond and cash investments tend to react differently to changes in market or economic conditions. The goal is to combine them so that the risks inherent in any one can be balanced by investments that move in different cycles or respond to different market factors. In this way, asset allocation may help you to help you mitigate risk by providing the potential to limit, or offset, potential losses in one asset class with stable values, or even gains, in another. Asset allocation can also help you maintain discipline through difficult markets.
Many investors tend to overreact to short-term market movements, making decisions that may be costly in the long run. They tend to buy when prices are moving higher, and sell when they’re heading lower. A well-constructed asset allocation strategy can help remove some of the emotion from investing, allowing you to make investment choices that are based on your needs – not the whims of the market.
While asset allocation cannot protect against a loss, especially in a bear market, it can help to contribute to longer-term portfolio growth. That’s because a properly allocated portfolio based on your goals, time frame and risk tolerance will help ensure you’re in the right position to profit if and when the market turns. To see how, consider the three hypothetical portfolios shown below.
Past performance is no guarantee of future results. This chart does not include the impact of taxes and costs of investing.
With the recent losses in the markets, many investors have found that they are no longer comfortable assuming as much risk as they have in the past. Others have found that market performance has caused their portfolio to drift from its intended mix.
(For example, instead of holding 70% stocks and 30% bonds, your portfolio may have shifted to a 55-45 ratio.)
That’s why now may be a good time to review your asset allocation strategy to make sure it is aligned with your specific circumstances, goals, risk tolerance and time horizon.
A Northwestern Mutual wealth management advisor will revisit your asset allocation and diversification strategy and help you rebalance your investments, as needed, to protect and strengthen your portfolio.
Through the use of our 10-point investment philosophy and asset allocation approach, your advisor can help provide the perspective, focus and discipline required to achieve relatively consistent and predictable results, regardless of market conditions.
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