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10 Ways to Minimize Portfolio Volatility

Posted on 17 November 2008 by Proldan

A bear market creates fear, uncertainty and costly mistakes.
The conventional definition of a bear market is a decline in stock prices of 20% or more, lasting at least two months. Whether or not Wall Street is in a bear market, every investor can have his or her personal bear as well. Your personal bear market is an unbearable price fall in the value of your nest egg.
You can experience two types of bear markets, temporary and permanent. Markets tend to go up and down and then back up. In a temporary bear market, you lose 20% or more but eventually recover. In a permanent bear market, you lose 20% or more and you never get it back. All the historical evidence I’ve seen indicates that a properly diversified portfolio has never suffered a permanent bear market over the long term. Unfortunately, some common investor behaviors can easily turn temporary losses into permanent ones.

It’s challenging to tell anyone to hold on once they have witnessed an extreme downturn in their portfolio due to market conditions. Yet, that being the case…the best thing to do is reassess the composition of one’s portfolio in light of its purpose and time horizon for its use. The traditional mantras of “diversification across sectors, geography, asset classes” still hold true over the long term. However, these are highly ignored during severe bear markets where emotions usually take over and lead to costly mistakes.

So it might be a good time to remind ourselves that even during tough bear markets:
Diversify – well diversified portfolios have not dropped as far as the market on the whole. This allows for a better recovery when the market does recover.

Assess Time Horizon – The level of volatility should be directly correlated to the amount of time one has until the assets in the portfolio are needed. In other words, the closer to retirement one is, the more conservative one’s portfolio should be.

Rebalance – history has shown that rebalancing can minimize volatility while enhancing returns. The basic notion is that buy identifying and maintaining a proper asset allocation, one will sell off assets that have appreciated to buy into assets that have depreciated. Adherence to this rule should eliminate much of the emotional elements of portfolio management.

Assess portfolio goals – if a portfolio has taken too much of a hit, a reassessment may require a realignment of goals (ie retire later, invest more now, etc.)

Unfortunately, while the above mentioned principles are not new, they are continuously violated by common investors who let emotions take over investment decisions. Panic can lead to mistakes, including the mistake of ignoring the portfolio rather than reassessing in order to retool one’s portfolio. Volatile times require more proactive measures. The market will have its ups and downs. But if one can follow these basic rules, one should be able to minimize the impact of the volatility relatively speaking over the long term. If you cannot apply these rules objectively, you should resort to the assistance of a financial professional that will help you in this area.

For professional investment advice on this topic contact:
Allgen Financial Services, Inc.
888.6ALLGEN (888) 625-5436
advisors@allgenfinancial.com
www.allgenfinancial.com

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