It All Starts With A Proper Strategy
The U.S. markets have been extremely volatile these last few weeks, but one thing that has stayed constant is the media headlines that point out all the records that have been shattered. Here are a few examples from this week alone:
“The blue-chip average surged more than 2,100 points, or 11.4%, to close at 20,704.91, its largest percentage gain since March 1933 after slumping to a three-year low a day earlier.”[i]
“The jump ends an 11-trading day bear market for the index—the shortest in history for the Dow—which reached its bear-market low three days ago.”[ii]
“The Dow industrials are still down 21% for the year, despite climbing 21% in the past three days—the largest three-day percentage gain for the index since 1931.”[iii]
It is no wonder why investors are left puzzled if more selling is to come or if the coast is clear. The headlines highlight the big down days and tout the huge up days. Yet very few actually discuss how an investor should navigate through this environment.
It all starts with a proper financial and investment strategy that emphasizes the difference between risk and volatility. The media accentuates the thought that risk and volatility are synonymous, but that could not be further from the truth. Volatility is how an investment moves up and down around its expected return, the more the market trades away from the average, the more volatile the environment. That is what we have seen over the last few weeks. Risk on the other hand, is derived from not having enough cash or cash equivalents to meet the projected liquidity needs from the portfolio. The risk comes from being forced to sell investments during a market downturn because that significantly increases the probability that the portfolio will be depleted. In other words, running out of money, which would lead to a substantial decrease in lifestyle.
At Surevest, we begin with a proper financial plan that maps out when money will be needed from the portfolio and the proper amount. These projected cashflows are then provided to the investment team who puts together a customized investment strategy to meet the liabilities. This process allows our clients the peace of mind that they will not be forced to sell in times like these. We will be detailing our investment process in great detail on our Quarterly Commentary, but I want to provide a quick glimpse.
We divide the portfolio into tiers and each tier has its own objective that is unique to each person’s financial plan. Here are the Tiers:
Tier One: Isolates 4-6 years of projected portfolio income needs away from stocks. The funds here are invested in the most secured individual bonds; we stay away from bond funds and bond ETFs because they have proven to be ineffective in this tier.
Tier Two: We invest in income producing securities that generate cashflow that is then used to purchase a Tier One bond. This allows us to constantly keep 4-6 years of projected need from the portfolio ready to send to our clients.
Tier Three: We look at growth-oriented stocks that have the potential for great returns. This section of the portfolio will experience higher volatility than Tier Two, but that is done by design. Money invested here will not be needed for 10+ years so more calculated risk can be taken to make outsized returns.
Every client’s preference is assessed, and a customized investment portfolio is designed that works hand-in-hand with the financial plan.
To illustrate why a tier approach works well, we will use Procter & Gamble (Ticker: PG) as an example. This stock is a constituent in our Tier Two because it has paid a consecutive dividend over the last 129 years and has increased its dividend for 63 consecutive years.[iv] Through all of the market downturns, like the Great Depression, Dot.com bust, and the Great Recession, this company has paid a reliable dividend. This is exactly what we are looking for in Tier Two because we count on the cashflow produced by the stock to help buy the next bond rung in Tier One. We are not worried when the stock drops in value so long as the company is properly managed in a way that does not compromise their ability to pay the dividend. As the chart below shows, Procter & Gamble has been volatile (blue), but their dividend has consistently increased (orange bar) throughout all the up and downs of the stock.
Over the last few market updates, we have mentioned some of the shifts we have made to our portfolio to take advantage of the market selloff. We have done this within the context of each tier mentioned. We have rebalanced our Tier Two to trim some of the stocks that have performed well, like Clorox, and buy those stocks that have unjustifiably seen their price decrease more than their fundamentals would suggest. In Tier Three, we have purchased stocks that are poised to do well coming out of this bear market, such as ServiceNow. We can make these moves because of the Tier framework we discussed. We understand how and when to adjust the portfolio to take advantage of the current and expected market environment, all while maintaining our client’s liquidity needs.
Look for our upcoming Quarterly Commentary to learn more about our approach and why we believe it is a superior way of managing our client’s money.
Disclosure
Clients and employees of Surevest own shares of all companies mentioned. This is not a recommendation to buy or sell any securities. Speak with your financial advisor before making any investments or acting on any topics discussed. Surevest Private Wealth is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where Surevest Private Wealth and its representatives are properly licensed or exempt from licensure.
