5 Ways to De-Risk a Portfolio

Christine Benz is Morningstar’s Director of Personal Finance. She writes a weekly column called, “Improving Your Finances”, on Morningstar.com. I consider Christine’s advice the best and most reliable that you can find online. She writes on timely topics that are relevant to her followers.

This week she discussed 4 Ways to De-Risk a Portfolio in Retirement. As always, I was in complete agreement with her advice. In fact, many of the investments that she recommended, I already own for most of my clients in or near retirement. Her four ways to de-risk a portfolio are higher dividends, diversification, timely rebalancing, and investing in high quality stocks.

Many smart investors have already taken Christine’s advice and are de-risking their portfolios. They are rotating out of the U.S., buying high quality companies with no debt and strong cash flows, favoring dividend paying companies, and diversifying into bonds. The investors who don’t heed this advice are going to experience the most financial pain when the correction does hit.

Bloomberg’s chart of the week showed the companies with the highest debt are vastly underperforming the market.  If you remove the “FANG” stocks (Facebook, Amazon, Netflix, Google), the companies with the highest debt trail the market this year by 14%! This same market action occurred during the lead up to the Great Recession in 2008. The market is also becoming very narrow, and if you remove the FANG stocks, the S&P 500 year-to-date return drops from 9% to 4%.

This week, Seth Klarman, who I believe is the 2nd greatest living investor behind Buffett, couldn’t have written a better statement that summarizes the current risk level of the market:

“When share prices are low, as they were in the fall of 2008 into early 2009, actual risk is usually quite muted while perception of risk is very high. By contrast, when securities prices are high, as they are today, the perception of risk is muted, but the risks to investors are quite elevated.”

There is more truth in these two sentences than anything I’ve read in a very long time. In the last 10 years, Seth has grown his hedge fund from a few billion to over $30 billion. He also wrote an investment book years ago that now sells for over $900 on Amazon. He is one of the few investors that bet against the housing market and he correctly anticipated the subsequent crash.

He considers cash a major part of his asset allocation. I’m sure that he would add cash as the 5th way to de-risk a portfolio. He keeps liquidity high and understands the potential downside of his investments. When the correction strikes, the most leveraged companies typically fall the fastest. Warren Buffett’s summed up excessive risk taking best with this famous quote, “Only when the tide goes out do you discover who’s been swimming naked.” The companies with the most debt or the investors who purchase illiquid investments are usually the ones caught swimming naked.

I’ll continue to help my clients stay invested in the market, while, at the same time, de-risking their portfolios, and keeping my clothes on!

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