The downturn in investment markets during the first half of 2022 has been the worst in half a century. Even conservative investments, like fixed income, have had a terrible six months with significant bond market declines. This alarming environment makes many ask themselves or an investment advisor: how do I safeguard my investments amid market volatility? 

While investing always involves risk, there are investment strategies that help to mitigate this risk of your portfolio. Four of these strategies will be explored in this blog, including diversification, asset allocation, active investment management, and time segmentation. 

Diversification

The premise of diversification is that a portfolio comprised of several distinct types of investments blended in a proper and calculated manner, will perform better and with less risk than a portfolio with fewer investments. Diversification works because different investments will react differently to economic conditions, reducing the overall portfolio’s volatility. When one or more investments are out of favor, others may rotate into favor. In the long run, diversification implies less volatility in your portfolio and creates a smoother investing experience amid market volatility.

Asset Allocation

Investments that share similar characteristics are organized into groups called Asset Classes. These groups are typically organized by:

• Type: stocks, bonds, commodities, real estate, and cash.
• Location: United States, international, or emerging markets.
• Size: large-cap, mid-cap, or small-cap. 
• Style: growth or value.
• Issuer: corporate or government. 
• Credit quality: investment grade or high yield. 

Asset Allocation is a common strategy proposed by investment advisors that combines different asset classes in a calculated manner based on an investor’s risk and objectives to build an efficient portfolio. Asset allocation is related to diversification in that it seeks to maximize your return for the amount of risk you take.

This chart is an example of diversification and asset allocation in action. The Balanced Portfolio, represented by the yellow box, is a blend of the S&P 500 Index, Small Cap stocks, Fixed Income, Emerging Markets (EM), International stocks (EAFE), and Commodities asset classes. Notice that in each year the Balanced Portfolio is never the best performer nor the worst performer. Unlike the individual asset classes, the Balanced Portfolio has the most stable, least volatile performance over time.

Active Investment Management

An educated and experienced investment advisor uses active investment management for client portfolios. Investment management requires adjusting the investments and asset allocation as market conditions change to mitigate volatility and maximize opportunity. 

Investment selection is an important component of active investment management. There are tens of thousands of investments to choose from, requiring extensive and ongoing research and screening, including alternative investments that are created to reduce risk in an investment portfolio. 

In addition to investment selection, a skilled investment advisor will look for opportunities and risks in different asset classes, overweighting investments that are undervalued and underweighting those that are overvalued. Active investment management also considers historical returns and earnings growth, tax efficiency, strategic and tactical asset allocation, and fixed income duration and credit quality. 

The best investment advisors, make changes to portfolios based on the market conditions, and are always seeking to reduce market volatility while maximizing investment returns.

Time Horizon Planning

When we invest, we are putting money away for a future goal or purpose. A projection of when we need that money should determine how we invest it. Using time segmentation allows us to choose the right investments for our financial plans. For example, if you are saving to purchase a new car in the next year, the right investment for that savings is cash. You safeguard your money by not investing it in the market which we know is volatile. Although you will not grow your savings, you know that 100 percent of the value will be available to you when you buy that car. There is no risk to money in an FDIC-insured bank account. 

Another example is geared towards retirement. In this case, if you are putting money into a retirement investment and your retirement is many, many years away, then equities (stocks) may be the right investment for this goal. Investing in equities over long periods of time has historically provided high returns and outpaced inflation, but not without significant market volatility. Since you have a long time until you need these funds, you have time to ride out all the ups and downs that we can expect from the market. While the market is volatile over short periods of time, you reduce your risk with a long-term outlook. 

Over the past century in the US stock market, 53% of single trading days were positive, 75% of any given year was positive, 87% of any five-year period was positive, 94% of any 10-year period was positive, and any 20-year period was positive 100% of the time. Using time segmentation is a technique to safeguard your investments amid market volatility by matching your investments to your time horizon. Short-term investments should be conservative with little to no risk, and long-term investments should be aggressive because time reduces risk.

Closing Thoughts

Diversification, asset allocation, active investment management, and time segmentation are strategies to mitigate the effect of market volatility on your investment portfolio. The best way to employ these strategies is to start with a financial plan, identifying what is important to you, defining your goals and objectives, and analyzing your financial resources. 

Implementing a successful financial plan starts with working with a trusted Wealth Advisor who will guide you through the financial planning process and use the four strategies we discussed to create an investment portfolio that complements your financial plan. A qualified financial advisor will help set you up for long-term financial success regardless of whatever volatility the market sends your way.