It’s May, and that means Mother’s Day!  As you know, Mother’s Day is a chance to tell our Moms how much we love and appreciate them.  A chance to say “thanks” for keeping us clothed and fed, safe and warm.

Yes, mothers sure do a lot, don’t they?  But did you know that most mothers play a huge role in our finances, too?

It’s not a role we talk about very often—and it’s certainly not a role they get a lot of credit for.  But when you think about it, mothers are hugely important in shaping a child’s financial future.  That’s because they’re often the first people to teach us good habits and important principles—principles that remain with us for the rest of our lives.

So in honor of Mother’s Day, we would like to pay tribute to:

Three Financial Principles Our Mothers Taught Us

1. Don’t waste your money on impulse purchases!

Do you remember when your mom used to drag you along to the grocery store when you were a kid?  Do you remember standing in the checkout aisle, begging for one of the candy bars on display?  After all, it seemed the least your mom could do given the fact she made you come all the way to the store with her!

But inevitably, your mom said “No, that’s not what we came here for.”  And that was that.

This may have been frustrating at the time, but your mom was actually doing you a tremendous favor: she was teaching you not to make impulse purchases.

Most of us earn money for three reasons: to pay for our basic needs (like food, shelter, clothes, etc.), to pay for goods or services we find enjoyable, or to save for a future goal or dream.  But impulse purchases, whether they’re as harmless as buying a candy bar, or as significant as getting that new electronic gadget everyone’s talking about, can be an enormous drain on your finances.  While it’s true that whatever you decide might be enjoyable, that pleasure tends to dissipate fairly quickly.

So when your mom said, “That’s not what we’re here for,” she was actually giving you a great bit of advice!  One of the best ways to grow your money and afford the things you truly want (as opposed to what you merely want right now) is to remember “what you’re really here for.”

2. The importance of saving and investing

Remember that summer when you decided to open up a lemonade stand outside your front house?  Chances are, your mom paid for the lemons, cups, and whatever else you needed.  But she also did more than that.  Imagine showing your mom all the money you earned—all those quarters, dimes, and the odd dollar bill.  Instead of letting you blow it all on bubblegum or trading cards, she probably told you to stick some of it in your piggy bank.  “After all,” she’d say, “if you save up enough money, you’ll be able to buy that 10-speed bike you keep talking about.”

In other words, your mom taught you the importance of saving.

In fact, chances are she did more than that.  “You know,” she’d probably say, “if you take some of the money you earned, you could use it to buy better lemons.  Or you could use it to buy the materials you need to make advertising signs and flyers.”  Soon, you were attracting more customers, selling more lemonade, and making more money.

So in a sense, your mom taught you the importance of investing.

Fast forward to today.  Saving and investing are a big part of reaching your financial goals, aren’t they?  So whenever you check off another item on your personal bucket list, make sure to thank your mom.

3. The basics of financial planning

When you were a kid, you probably saw your mom take the time to balance the checkbook or hang a “to do” list on the refrigerator.  You probably didn’t think much of it at the time, but your mom was demonstrating the basics of financial planning.

Financial planning is the process of determining what you want, what you need, and what you must to do to acquire both.  It’s that simple.  And that’s what your mom did every day, every week, every month.  She devoted so much of her time and energy into determining what the family wanted (a vacation to Disneyland, presents under the Christmas tree), needed (new clothes for the kids, food in the refrigerator, college tuition), and how much she’d have to earn, save, (and when times were lean, maybe even scrimp) to get the family both.  All throughout your childhood, your mom never stopped planning for the future.

And that’s why you never stop planning, either.

So this Mother’s Day, let’s make sure we all take the time to tell our moms “thanks.”  Thanks for always being there.  Thanks for every headache, heartache, and sacrifice on our behalf.  Most of all, thanks for every lesson—about money, life, and everything.

Remember: our moms have always invested in us.  Let’s make Mother’s Day one small return on that investment.

On behalf of everyone here at Minich MacGregor Wealth Management, we wish you a Happy Mother’s Day!

Celebrate Financial Literacy Month

April isn’t just the first full month of spring … it’s also Financial Literacy Month!  The United States Senate first proclaimed April as Financial Literacy Month back in 2004, in order to promote good financial habits and the importance of financial education.

How important is financial education?

In 2002, Alan Greenspan, then chairman of the Fed, said in prepared testimony before the U.S. Senate Committee on Banking:

“… Education can play a critical role by equipping consumers with the knowledge required to make wise decisions when choosing among the myriad of financial products and providers. In addition, comprehensive education can help provide individuals with the financial knowledge necessary to create household budgets, initiate savings plans, manage debt, and make strategic investment decisions for their retirement or children’s education. Having these basic financial planning skills can help families to meet their near-term obligations and to maximize their longer-term financial wellbeing. While data available to measure the efficacy of financial education are not plentiful, the limited research is encouraging.”¹

When you come right down to it, financial education is all about making good financial decisions and avoiding bad ones.  Since the recession of 2008, making good financial decisions is more important than ever.  It doesn’t matter who you are, where you live, or how much money you make.  Nowadays, people just can’t afford to make bad financial decisions anymore.

Furthermore, the benefits to making good decisions are substantial.  According to the Financial Educators Council, “Research shows that individuals that have taken a personal finance education course have higher savings rates, higher net worth, and make larger contributions to their 401(k) plans.”² Add all that up, and it means financially literate people have less debt, a better retirement, and more money to live life the way they want to.

As a financial advisor, here are just a few topics we recommend taking time to educate yourself on:

Ÿ  Your cash flow.  Do you actually know how much you’re bringing in versus how much you’re spending?  Understanding and improving your cash flow is one of the most important things you can do to save for the future and reach your financial goals.

Ÿ  The level of risk in your investment portfolio.  Many people invest too conservatively when they’re younger, reducing the chance of building a sizeable nest egg during their prime earning years.  Conversely, many people invest too aggressively when they’re older, when they simply can’t afford to lose a large chunk of their retirement savings.  Nobody does this on purpose—they simply don’t realize they’re doing it at all.

Ÿ  What kind of insurance you have and how much you’re paying for it.  It’s not uncommon for us to review a client’s insurance policies, only to find that they could either be paying less for what they’re getting, or getting more for what they’re paying.

Ÿ  Financial security.  These days, it’s easier than ever to fall prey to fraud or identity theft.  It’s critical to know how you are vulnerable and what you can do to protect yourself.

Ÿ  Estate planning.  Do you have a will?  Have you set up your Power of Attorney?  What about your Advance Medical Directives?  It’s never pleasant to think about the inevitable, and if you’re young and in good health, it’s easy to just dismiss the idea altogether.  But take it from us: the peace of mind that comes with knowing your legacy is secure and your family taken care of (even if something unexpected happens) makes it all worth it.

There’s no better way to spend the month of April then to take a little bit of time learning more about your own finances.  We’ve sent you information on many of these topics in the past, and we’ll continue to do so in the future.  But if you ever have any questions, don’t hesitate to let us know.  We’d be happy to sit down and talk with you.

In the meantime, never discount the value of a good education—especially when the topic is your own money.

Happy Financial Literacy Month!

¹Greenspan, Alan. 2002. “Prepared Statement.” Hearings on the State of Financial Literacy and Education in America. U.S. Senate Committee on Banking, Housing, and Urban Affairs, February 6.

²Shorb, Vince, “Financial Literacy and the Revival of the American Dream,” National Financial Educators Council, accessed March 29, 2013. 

Weekly Wire – The Oil Slick That Stocks Are On

Historically, oil prices and the US Stock market are not highly correlated. Meaning, when one goes up or down that does not necessarily signify the other is going to follow suit. However, right now, we are definitely seeing more of a connection between the two.

Over the weekend, OPEC met in Doha, the capital of the peninsular Persian (Arabian) Gulf country Qatar.  The goal was to set a production freeze in order to keep prices from falling too much because of increased supply levels. For several reasons, the talks failed to produce a freeze therefore production continues and oil prices continue to fall.

At the pump we all like lower gas prices, no question about that. We can’t recall ever hearing someone say, “I wish this gas was a bit more expensive”. So why are the equities markets so nervous about something consumers like?

This is an oversimplification, but in a nutshell, oil is big business that has a large debt load with financial institutions globally. Financial institutions are also big business. If the profits from oil drop too low, the companies that rely on oil profits experience a diminished profit and may end up being unable to pay back their debt to the financial institutions.  As a result, two very large sectors suffer and the related stock markets take a hit.

In one of our recent Weekly Wires we asked: Does it make sense to total the car over a flat tire? The answer is “no”.  Taking a complete defensive approach to all equity holdings based solely on the falling price of oil may be akin to totaling the car. However, being selectively defensive using a sector rotation strategy may not be a bad idea.

For now, our advice is to enjoy the low prices at the pump, but realize those great prices may be signaling a change in sector leadership in your portfolio.

Markets and Election Years

Every four years, Americans take a few minutes out of their day to choose the next President of the United States.  Voting is a simple, uncomplicated act—but the months preceding it are anything but.  After all, before we vote, we first have to endure the dreaded “campaign season.”  From endless televised debates to the plethora of signs on our neighbors’ lawns, “politics” becomes the order of the day.

If you’re like us, you’re probably starting to get tired of all the campaigning.  But you also know how important the political process is.  Being an informed, engaged citizen is crucial to maintaining the stability of our Republic.  That means asking some pretty tough questions, like: “Which candidate best represents my opinions and values?”  “How will each candidate affect our standing overseas?”  “What will each candidate do to ensure both our safety and our personal liberties?”  Getting the answers can be both frustrating and time-consuming.

Fortunately, there’s one question you don’t have to ask.

“How will the election affect the markets?”

This is a question we get every four years.  This year, we thought we’d make life a little easier for you by answering it now.  That means you have one less question to worry about!

So how does the election affect the markets?  The answer is:

Not much.

Since 1833, the Dow Jones^® has gained an average of almost 6% every presidential election year. ¹ That number increases to 9.5% for the S&P 500^®.²  Of course, there can be some massive exceptions.  For example, in 2008, the Dow sank nearly 34%.¹

But there’s a danger in using averages to try and predict what will happen.  Take the “Presidential Election Cycle Theory” for instance.  Once upon a time, many people believed that U.S. stock markets are always the weakest in the year following a presidential election.  This was the case for Franklin Roosevelt.  It also held true for Truman and Eisenhower.  But in George H.W. Bush’s first year, the market rose 25.2%.  In Bill Clinton’s?  19.9%.  Barack Obama?  15.4%.³ It’s clear that the Presidential Election Cycle Theory just doesn’t hold water.  And that’s true for actual election years as well.  An average merely shows you what has happened, not what’s going to happen.  (Side note: this is why you often see the financial industry emphasize that “Past performance does not guarantee future results.”  Because it’s true.)

“Okay,” you might be saying, “so there’s no hard and fast rule on how election years affect the markets.  But what if the Democrats/Republicans win?  Won’t that have an effect?”

Our answer:

Not really.

As worked up as we often get about our political beliefs, neither party tends to have that much impact on the markets compared to the other.  Historically, the Dow has gone up an average of 9% every year a Democrat lives in the White House.  With Republican presidents, the number is 6%.¹ The difference is very small, and can be attributed to a whole range of factors, not just politics.

“So you’re saying it doesn’t really matter who ends up getting elected?”

Obviously, it matters a great deal who our president is … but not when it comes to the markets.  And that’s a good thing!  Here’s why:

1. The Founding Fathers created a system of government where no branch (executive, legislative, or judicial) was supposed to dominate the other. The fact that neither political party, nor election years in general, have that much influence on the markets shows that our system of checks and balances extends to investing, too.
2. The markets are driven by far more than just one person or event. They’re controlled by the ebb and tide of trade, by the law of supply and demand, by innovation and invention, by international conflict and consumer confidence.  The markets are like life.  The course our lives take isn’t determined by one gigantic decision, but by the millions of small decisions we make every day.  We don’t know about you, but we find that comforting.

“So what’s the takeaway from all this?”

The takeaway is that when it comes to investing, we control our own destinies, not politicians.  The way to reaching your financial goals is by having a sound investment strategy, making informed decisions, and taking emotion out of investing.  Not by worrying about the election.

So this year, as you watch the debates, chat amongst your friends, and decide who you want the next president to be, you can do so with the knowledge that whatever happens, the markets will go their own way … and so will you.

Market leadership change and momentum investing

Investopedia defines momentum investing as:

“Momentum investing is an investment strategy that aims to capitalize on the continuance of existing trends in the market. The momentum investor believes that large increases in the price of a security will be followed by additional gains and vice versa for declining values.”

One of the key pieces of data needed to implement a momentum strategy is knowing which sector is outpacing the pack. The good news is once leadership is established they often stay leaders for a fairly good stretch of time. For example, biotech and healthcare had been consistent leaders over the past several years. The bad news is momentum investing can be, shall we say, frustrating when there is a change in leadership.   It is a waiting game where unbiased data analysis is intensive but action is slow.  It is a period where the proverbial “head fake” is common and you have to count on being wrong some of the time which is often frustrating for investors that do not have a well thought out, written investment strategy.

Closely related to momentum investing is trend analysis. A trend is really nothing more than the general direction in which a security or market is headed. That direction can be one of three directions – up, down or sideways.  During a leadership change, trend lines for various sectors are often sideways  until one or more of the sectors break out of that trend and establish new leadership.

Momentum investing predictably goes through a period of underperformance during these changes in leadership or sideways trends.  However, over time, momentum strategies executed with discipline often outperform their buy-and-hold strategy counterparts during periods of growth as well as decline.

So where are we now? Although there are some promising signs for new leaders, by most definitions, we are still in a fairly sideways trend in the equities markets. We are watching for the next leaders to emerge and settle in, knowing there will be some “head fakes” along the way.

Read more: Momentum Investing Definition | Investopedia http://www.investopedia.com/terms/m/momentum_investing.asp#ixzz44D0N96CL
Read more: Technical Analysis: The Use Of Trend | Investopedia http://www.investopedia.com/university/technical/techanalysis3.asp#ixzz44D62NF7C
 

Easter

Easter is a time for gathering with family and friends. In our families it is usually a ham or lamb dinner. We all have different traditions for this holiday; one of the most common traditions is the decorating of eggs.

Historically, eggs have been thought of as symbolic of the sun, new life, and new birth. Because of this perception, they became a natural fit to be included in spring festivals of new growth and new beginnings. It’s uncertain where the tradition of decorating eggs began, but what is certain is that this tradition took a strong hold in Eastern European culture. This tradition led to the creation of the famed Fabergé eggs.

Peter Carl Fabergé, born in St. Petersburg, Russia in 1846, was named the goldsmith and jeweler to the Russian court in the 1880s. Czar Alexander III had him create an elaborate Easter egg for the Czarina Alexandra in 1885. The Czar made these eggs an Easter tradition throughout his reign, and that of his son and successor, Nicholas II. Fifty such imperial eggs were created before the fall of the house of Romanov in 1917. In 1918 Fabergé’s firm was closed by the Bolsheviks, causing him to flee to Switzerland, where he died in 1920. The Fabergé eggs are some of the most valuable pieces of art in the world.

The lesson we can learn from Czar Alexander is that he gave the best that he had to his friends and family. Our hope is that we are able to do the same with those who are closest to us. Please enjoy this spring season and especially this Easter holiday.

St. Patrick’s Day

In 1736, a young man named George Taylor emigrated from Ireland to Philadelphia.  With almost no money, Taylor had little choice but to indenture himself to an ironsmith in order to pay for his passage.  In those days, working as an indentured servant meant years of hard labor and little freedom, but it was a course thousands of Irish men and women were forced to take in order to live in the New World.

Forty years later, Taylor signed the Declaration of Independence.

There were 56 signers of the Declaration, but Taylor was one of only eight who had been born in a foreign land.  The fact that a poor Irish immigrant could rise to such a stage might seem incredible, but American history is filled with contributions made by Irish immigrants.

This month we celebrate St. Patrick’s Day.  As you probably know, St. Patrick’s Day can mean many things to many different people.  At its heart, the day is to honor the death of Saint Patrick, one of the most important figures in Irish history.  Children, of course, see it as a chance to wear green.  More recently, though, we’ve come to associate the holiday with a celebration of Irish culture in general.  To us, that’s a good thing—because Irish culture has had a profound influence on American culture, too!  For that reason, St. Patrick’s Day gives us the opportunity to acknowledge the contributions made by thousands of Irish Americans over the centuries.

Irish immigrants began settling in what would become the United States during the 17^th century.  By the time of the American Revolution, over 250,000 Irish people had settled here.  From the start, many of these brave men and women adopted the cause of Independence and went on to serve under George Washington during the Revolutionary War.  In fact, one British general stated that “half the Rebel Continental Army were from Ireland.”

The second great wave of Irish immigrants came during the 1840s during the Great Famine.  When a disease struck Ireland’s potato crop, a million people left the island to get away from the mass starvation taking place.  Thousands of them came to the United States, where they settled in cities such as Boston, New York, and Philadelphia.  When the Civil War broke out a decade later, many Irishmen formed their own units, such as the famous Irish Brigade, one of the most celebrated units in Army history.  Some historians estimate that more than 140,000 soldiers were from Ireland, while many thousands more were of Irish descent.

But Irish immigrants didn’t just distinguish themselves on the battlefield.  From religion to music, from law enforcement to literature, and from food and drink to sports, Irish culture has influenced many of the traditions, customs, symbols, and sayings we know so well today.

Perhaps the biggest influence the Irish have had on American history is in the halls of government.  Besides George Taylor, two other Declaration-signers were Irish, while five were sons of Irish immigrants.  Most significantly, President Andrew Jackson was born to Irish parents, and twenty one other presidents have had Irish blood in their veins.

So as you wear green, count the leaves on a clover, or take in your local parade this St. Patrick’s Day, remember that it’s not just the Emerald Isle we’re celebrating—but the link between those green shores and ours.

From all of us here at MinichMacGregor Wealth Management, we wish you a happy St. Patrick’s Day!

Siri®, is my route clear?

From our earlier articles, you know that tactical asset allocation involves having a well thought out system which allows you to change your mix of stocks bonds cash, etc. based on current market conditions. One of our data partners recently published an article which draws an interesting parallel between tactical asset allocation and taking a road trip. We think the analogy is amazingly close!

Here is an excerpt from their article:

We’ve all been on a road trip that starts out smooth sailing.  Maybe it’s a clear, sunny day. There’s no traffic, the gas tank is full, and you’re well-rested; so you flip cruise control on and you’re on your way.  Then, up ahead you begin to see more and more break lights illuminate as traffic slows and the road becomes more congested.  At this point, what do you do?  Leave your foot on the gas, and brace for impact? Of course not!  You adjust to avoid catastrophe and reevaluate.  If you cannot clearly identify the cause of the traffic ahead, how far it will last, or how long you will be delayed, you might even begin to search for alternate routes.  Perhaps the alternate route is on a slower speed road with traffic lights along the way.  Perhaps it adds an extra 30 minutes to your original travel time.  At that point, you have a decision to make. Will you do nothing, and hope the traffic clears without too long of a delay; or will you adapt, and take a clearer route knowing it might take a little longer than your original plan?  Each driver may have a slightly different answer here based on certain variables.  For instance, how much gas do you have?  When did you last eat? How many times will you have to hear, “are we there yet?”  Some drivers may choose to change their path immediately, some may be okay just waiting it out, and others may take the opportunity to pull off at an exit, stretch their legs, and grab a bite to eat.  

This example is analogous to the type of market we are in now.  We aren’t at a complete standstill, but we also can’t see up ahead to know if the worst is over or if there’s miles of traffic to come.  All we can do is take the information we have at hand and make the best decision possible.          

We all encounter “traffic jams” at some point.  How do we deal with them?  Do we find an alternate route or do we sit and wait it out?  In our investor analogy there is no question of what to do with a static allocation approach.  You wait and sit in traffic, no matter what.  Just sit.

However, as is the case in the market, there is typically a point at which most drivers get fed up with waiting.  When they have reached this point, they can’t take it anymore and in many cases a rash, emotional decision is made.  In an effort to deal with the traffic jam, they zig and zag or change their route, only to look back and see the original route is now clear.  They made the mistake of either waiting too long to make a decision or they made a uniformed decision. They didn’t have enough data or a calculated plan before they encountered the traffic.  Allowing “road rage”, or an emotional reaction to influence your decisions does not often end well. Most people only have to make this mistake a few times before they start to believe doing nothing is the only way – and they sit.

However, with some technology, a little planning and the right data, making a well thought out, non-emotional decision is possible. In traffic, iPhone users might say: “Hey Siri® – Is there a faster way to my destination?”

Though there is no magic “Siri®” for executing a tactical allocation strategy for your investments, the traffic analogy can be applied to how we handle the market’s volatility.  The cars are equities; the buses are bonds and the car carriers can be mutual funds.  If you have a plan in place to follow when things become uncertain, you will be better equipped to handle it than the person to the left that decides to blindly buy and hold and the person on the right that reacts based on emotion.  We all want to be the motorist…or investor…that makes good time…or money…and arrives safely at our destination.

Risk Management:

Tactical Asset Allocation and Sector Rotation

Risk management is a broad term used for any steps taken to protect a portfolio from loss. However, there are different types of loss and different risk management strategies for hedging against each.

Diversification

Diversification, better known as the “don’t put all your eggs in one basket” strategy, helps protect against absolute loss.  For instance, if you own two stocks equally and one of them goes out of business, then your portfolio takes a 50% hit.  If instead, you own 100 stocks equally and one of them goes out of business you would only take a 1% hit in your portfolio.  Mutual funds and ETF’s are a common way to manage the risk of absolute loss through diversification because by design they are comprised of many different securities for a specific investment objective. For example, assume you own an S&P 500 index fund.  In reality, you own a small portion of 500 different companies. If one of those companies were to go out of business and its stock price went to zero, the fund may go down in value but you would be protected from absolute loss.

However, simply diversifying your portfolio does not protect you against market losses. For example, owning an S&P 500 index fund does not protect you against the market for US large company stocks going down as a whole. That risk needs to be managed with different strategies.

Asset Allocation

We want to take the “don’t put all your eggs in one basket” diversification strategy one-step further. If large company US stocks as a class are down 25%, and you own that broad asset class investment, you can expect that asset class in your portfolio to be down around 25%. There is no inherent risk management being applied to this type of market risk simply by owning mutual funds or ETFs. To help offset some asset class risk, investors typically construct a portfolio where a certain percentage of their portfolio is represented by different broad asset classes like stocks, bonds, cash, real estate, etc. This helps manage the risk of having all of your money in one asset class.  If one class is down, it is less likely that all of the classes will be down – you are managing some risk.

Setting the appropriate allocation percentages is a challenge because the optimal allocation at any given time for your specific situation changes based on the current market conditions. For this reason, a static allocation strategy, which commonly is only reviewed on an annual basis, may not allow enough flexibility to effectively manage asset risk at the broad asset class level.

For example, assume you have a static allocation of 60% stocks and 40% bonds and you rebalanced your portfolio on January 1st. However, by the end of the first quarter, stocks were down 20% and bonds were up 5%. Intuitively it makes sense that a better allocation at that point might be 50% stocks and 50% bonds, but your allocation is static so you ride it out.  By the end of the third quarter, stocks are down 30% and bonds are up 10%.  Your original allocation of 60/40 now seems far off given the market conditions.

Tactical Asset Allocation

A tactical asset allocation strategy requires more frequent monitoring and a good bit of unbiased data, but puts in place a set of rules that help to change your allocation mix based on specific metrics in each asset class.  In the example above, during the first quarter it is highly unlikely that stocks dropped 20% in a day or two. It is more likely that the decline happened over several weeks.  A tactical allocation approach may have shifted a percentage of the stocks to bonds or even cash after the first “x”% decline. Fast forward to the third quarter and a tactical allocation strategy may have shifted a sizable percentage of the stocks to bonds before it got to that point – helping to have avoided some of the large loss. The process and metrics are of course more complex than this.  The important concept here is that having an adaptable process can help manage broad asset class risk.

Sector Rotation

Another risk management strategy is sector rotation.  Owning securities representing different sectors within an asset class further diversifies a portfolio and allows the implementation of a sector rotation strategy. It is important to understand that within any broad asset class, there can be a significant difference between the best performing sectors of that class and the worst performers – in good times and in bad. For example, for the large company US stock market asset class, the difference between the worst performing sector and the best performing sector often is more than seventy percent in any given year. That means that although the average for that asset class might have been 10%, there were likely sectors within that class that were up as much as 45% and other down as much as 25%.

From a risk management standpoint, a sector rotation strategy may give you the ability to sell sectors that are showing signs of weakness and buy sectors showing signs of strength. Over the past couple of years for example, the biotechnology and healthcare sectors significantly outperformed the basic materials and precious metals sectors. However, over the past few months, precious metals have outranked both biotechnology and healthcare, while basic materials has stayed near the bottom. Utilizing a sector rotation strategy may have allowed for the rotation away from biotechnology and healthcare while looking for other sectors on the rise.

Risk management is such a broad term it is easy to be confused as to which risk you are managing, or are having managed.  There are many risks in the capital markets that, with some effort and data, may be managed through a variety of strategies. Knowing which strategy to use, the data you will need, and how to implement it is a complex problem. Asking a professional is a good first step in solving it, but be sure you know which risks they are willing to actively manage – often times the answers vary more than people think.

Combining asset allocation strategies, tactical management and sector rotation is not a panacea to market risks.  However, remaining adaptable, process driven and willing and able to make changes when necessary is a great start.

Check out these links on Investopedia for more reading:

Diversification: http://www.investopedia.com/terms/d/diversification.asp

Sector Rotation: http://www.investopedia.com/terms/s/sectorrotation.asp

Tactical Asset Allocation: http://www.investopedia.com/terms/t/tacticalassetallocation.asp

Totaling the car over a flat tire – Sector Rotation a Big Picture Look

Your faithful car still runs well and is in good shape.  This is despite the ding in the door from the runaway shopping cart and that crayon mark on the backseat from your child’s attempt to “fix” it.  One morning, while driving your faithful car, you get a flat tire after hitting a pothole.  Time for a new car? We are fairly certain you wouldn’t throw your hands up, declare your faithful car a total loss and buy a new one.

When news about the stock market is “bad”, and the numbers support it, we believe playing defense is a good plan.  In this case, would you throw your hands up and sell all of your equities to cash, only to wait for a sign to show you that everything is peachy so you can buy back into the market?  This seems like a bit of an overreaction.  Not to mention there were likely some equities in your portfolio with decent performance – why get rid of them?

So now the question becomes: How do you identify what to sell and what to keep? This is where sector rotation comes in.  If you break the equity market down into segments, by industry, size, country, etc., you can track and rank these sectors individually and identify which are outperforming or underperforming the others.  If a sector is falling in ranking and another is rising, rotating out of the one that is falling into the one that is rising is like fixing the flat tire instead of selling the car. Another benefit of this strategy is it allows you to let those sectors that are really outpacing the rest to continue to grow – just a few sectors that are doing significantly better than the others can have a big impact on your portfolio.

This image is from one of our monthly seminars. It is an example from a few years ago highlighting the change in ranking of two specific sectors over a 4-month period. Notice the change in ranking for Small-Cap US stocks and All US Fixed Income Quality (bonds).  Since small-caps were falling and bonds were rising, would it have made sense to sell all your equities and move to bonds?

Look at what stayed in the top 10 – a sector rotation strategy may have allowed you to keep your internet, emerging markets and real estate holdings, and move only those sectors which were going out of favor.

Sector rotation, like all investment strategies is not a perfect science; however, we believe that by adding it to your portfolio management toolkit you may be able to be a bit more selective with your defensive moves and strategic with your offensive ones.