Asset Allocation in a Volatile Market

A recent Asset Allocation Survey conducted be the American Association of Individual Ivestors recently signaled an increased aversion to equities, with stock/stock fund allocations falling to 53% last month. Many investors, both individual and institutional, are frustrated by the market’s headline-driven volatility, and some are just plain scared by it.

In order to protect retirement savings from further down drafts in this type of market, investors often seek to simply move to all cash and wait for an “all clear” signal. The effect of this can be seen recently when outflows from US domestic equity funds totaled $6.67 billion last week – the largest amount of weekly withdrawals since August 10, 2011, according to research from the Investment Company Institute. However, by acting in a herd mentality, investors run the risk of waiting too long to reenter the market. Momma market is a hard teacher and she never gives you the “all clear” signal until after you have already missed out on big gains. Although we are inclined to advise many clients to sit out any immediate new investments into this market, we remain mindful of this fact. So, the secret is to keep investing in stocks (if your financial goals call for it), while not taking unnecessary risks. Here two specific things to focus on:

Allocation – In a difficult environment, your financial tolerance for risk can be higher than your emotional tolerance. Thus, it is your financial tolerance that should govern your allocations, especially if you have a long investing time horizon. Simply put, the longer the time period before you need the money, the bigger the threat inflation becomes and greater the need to include stocks in your portfolio. If you are really nervous, cut back on your allocation to stocks a little and rebalance your portfolio when your allocations drift off target by five percentage points or more.

Valuation – Remain alert to current value statistics. Cognizant investors know that 84 S&P 500 member companies trade with a price-earnings ratio below 12 AND a price-to-book ratio below 2 at the end of last week. With so many cheaply valued stocks, its hard not to be compelled to find bargains in certain sectors of the market. Granted, some stocks are cheap for a reason, but there are enough with both low valuations and good fundamentals to qualify as bargains.

Finally, realize that the market’s volatility and slow economic growth could continue for a while. It may not be pleasant, but sometimes the best strategy is to grin and bear the short term, while investing for the long term.