Talk about the weather.
Everybody talks about the weather but nobody ever does anything about it.
We live in the Okanagan for many reasons one of which is the weather. In November it averages about +2c to -3c*. Not bad, eh. But sometimes when we get a blast of weather, like November 29th when it hit -15c plus the wind-chill, it didn’t feel average. What did we do? We didn’t pack up and leave because we know that usually it’s more like, well, average.
What can be done about the weather? We can prepare for it. We can keep our long-johns handy and put on our winter tires.
Stock markets can be like the weather.
In Canada, stock markets average about 6% to 9% plus inflation over time**. If inflation is about 2.5%, we can expect returns to average about 8.5% to 11.5%. Sometimes, stock markets look anything but average. Remember 2000? 2001? 2002?
** Financial Analysts Journal, January/February 2004, Dimson, Marsh and Staunton.
If stock markets aren’t average, we don’t have to pack up and leave.
What can be done to prepare for nasty stock market weather? Plenty.
There is never a bad time to review your investment policy and asset allocation.
If you see storm clouds on the horizon, now is the time to review your investment portfolio not after the stock market temperature drops.
Make sure your investment policy is appropriate for you. Make sure it still reflects your long term goals, and, this is important; make sure it reflects your ‘true’ risk tolerance (your tolerance for volatility … not your capacity for risk).
Asset allocation is the implementation of your investment policy. Your long-term performance and the level of volatility you can expect are determined by your asset allocation. Make sure you have enough bonds. Would you benefit from more diversification? The broader and more global the diversification, the smoother the ride – the warmer the storm – should markets become more inclement.
Rebalancing helps to reduce volatility. With stock markets yielding double digit returns for four years in a row now, your current asset allocation may have drifted from your long term policy allocation. Take profits and reduce risk and, this is the hard part, rebalance to the areas that may not have performed as well.
We can’t control the weather. We can’t control the stock market. But we can prepare for unexpected weather and we can give our investment portfolio a flu shot.
Originally published in the Business Thompson Okanagan news, April 2007.
Doug Cronk CFA is Manager, Investments for a Canadian Pension Fund.