Protecting income and lifestyle

The investment markets clearly know how to rattle the investor’s nerves. From 1991 to 1993, from 1995 to 1999, and from 2003 to 2007, it seemed everything was in alignment and the markets went up. But each of these three time periods were interrupted with a market correction of various lengths and size. In fact, the current value of the S&P 500 was last seen in 1997, thus wiping out over a decade of appreciation.

With cash earning very little and bonds rarely providing more income than current inflation, the typical investor questions how to grow their accounts to prepare for retirement, and once retired, how can their income be protected? We will try to provide one or more answers to these questions.

During this recession, a buy and hold strategy obviously does not work. Corporations that were thought to be solid are now gone, along with millions of dollars in value their stock once represented. For others, their stock is still significantly below past market highs. Mutual funds are the product for the masses and used by many to create instant diversification. However, they did not fare much better than the market. Many equity mutual funds were down as much if not more than the market.

If buy and hold does not work, and mutual funds still had substantial losses despite their diversification, then what is the option? Unfortunately, there is not a crystal ball providing the guidance as when it is best to sell and to buy. One strategy can reduce the pain, and it does not use any special product. A truly diversified portfolio with investments in cash, bonds, real estate, and equities will fare much better over the long term than any single allocation. But this does not mean owning one equity fund creates the diversification needed. Equities are represented by small, medium, and large firms. They also represent US based businesses as well as those based outside the US. There are also those firms representing a value base and those representing growth. Additionally, there are many industries, and not all funds invest in all industries. Therefore, depending upon the size of the portfolio, the number of required funds can vary considerably.

This is also true for bond portfolios, since they can represent US Government bonds, municipals, and corporations. The duration a bond has until maturity also impacts performance as does the quality. Here again, just one or two bond funds may not provide the protection and diversification needed for the portfolio.

Once the allocation is created, then the fund selection has to start. Not all providers have the best fund in each area of the allocation. Many of the most notable names are also the largest fund managers but not necessarily the best when performance and risk is considered. Owning funds in more than one fund family can be the solution, but this is not always possible if commissions are involved. Using self-directed accounts can provide this access, or using an advisor that manages the funds like QFC can also be a solution.

The allocation is prepared, the funds are selected, and the purchases are complete. If you believe you are set, you are wrong. Our investment world is ever changing, and to properly manage the funds, the allocation should be reviewed at least quarterly and more frequently if unexpected events occur. Therefore, with regularity, the allocation should be modified to continue to protect the account during difficult or uncertain markets and positioned to participate in the market’s growth during prosperous times. While this sounds easy, it is not. To make these changes requires an understanding of the markets and many tools to evaluate how and when to make changes as well as the selection of new investment choices.

This concept is partially supported by a recent study prepared by one of the larger 401-K administrators. When they reviewed the performance for the past 15 months ending March 31, 2009, they determined the average 401-K account dropped by 17 percent rather than the 44 percent decline of the market. The report was not clear whether it took into consideration new deposits or not, but regardless, this is still better than the market. The report pointed to diversification of holdings, and the continuation of additions aided in the result. The ability to ride the market through the decline and into the recovery is very beneficial, but is only available to investors who are not presently taking withdrawals.

If creating your own allocation and monitoring the holdings and economy in order to make modifications is not your cup of tea, then next week’s discussion on financial advisors and variable annuities may prove beneficial.

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