Tactical Allocation for Tough Markets

Today’s economy may be booming and the markets rising (with some bumps here and there), but that doesn’t mean investors do not face challenges. Balancing growth with risk is always a concern, especially as you near retirement. Where can you turn for help?

According to traditional investing wisdom, the solution is diversification. Holding investments from different asset classes, including equities, bonds, and cash, allows you to increase your chances of obtaining a compelling total return.

Some diversification strategies are passive, meaning they buy and hold securities for the long term regardless of market fluctuations. A mutual fund, for example, may have a prescribed allocation mix of 60 percent equity, 30 percent bonds, and 10 percent alternatives. This would not change, even as the equity market rallies and the fixed-income market flounders.

Other diversification strategies are active, meaning they adjust to evolving market conditions by moving assets as the markets change. Portfolio managers using strategies such as these may have the flexibility to shift entire asset classes in response to market fluctuations, for example. If alternatives perform badly, the portfolio manager may exit alternatives altogether. These are also called tactical allocation strategies.

Advocates of tactical allocation strategies believe these strategies may benefit investors in volatile markets. When market risk is low, a portfolio manager can increase exposure to growth by allocating assets to the market’s top-performing sectors and countries; when market risk is high, the portfolio manager can preserve capital by shifting to bonds and cash.

Does it work? No investing strategy is appropriate for every investor. You have to find the one that balances your desire for growth with your tolerance for risk.

We can provide you with more information about what might be suitable for you given your individual financial circumstances, goals, and risk tolerance; please reach out to us for more information.

The Importance of Duration When Buying Bonds

Equity market volatility drives some investors out of stocks and into bonds, which are often perceived to be less risky. Certainly, bonds do not have the same kind of risk equities have.

But bonds also have risks, and perhaps the greatest such risk is interest rate risk. This risk can be managed by looking at something called duration.

First, it is important to understand how bond prices work. Typically, bond prices move in the opposite direction of interest rates. Higher interest rates drive bond prices down, and lower interest rates drive bond prices up.

The risk that your bond price will fall because interest rates rise is called interest rate risk. And when purchasing shares of a bond fund, you can help manage this interest rate risk by paying attention to the fund’s duration.

Duration may sound complicated, but it is just a number that indicates the percentage change in the price of a bond fund for each 1 percent change in interest rates. So, if the bonds in a particular fund have an average duration of five years, for each 1 percent change in interest rates, the bond fund’s price should move 5 percent in the opposite direction.

The lower the average duration of a bond fund, the less price sensitivity the bond should experience. So, if you are a risk-averse investor, you may want to consider bond funds with shorter durations.

It is typically easy to obtain this information from a bond fund’s website or prospectus. You can also ask us. Feel free to contact our office with any questions about bond investing.