Steadiness Through the Chaos

It was a stormy week for stocks and bonds as indexes were rocked by the uncertainty of Greece’s fate, the near-$4 trillion rout of Chinese stocks, the hours-long halt on the NY Stock Exchange, grounded United Airlines planes, and tumbling oil industry shares. With stocks rising and falling 1% to 1.5% in a day, one might easily think that his portfolio was bouncing about in similar fashion.

Well-designed portfolios mute volatility and efficiently harness the excellent returns available in the capital markets. To demonstrate, let’s dissect our Balanced portfolio and its performance over the past four days (Monday – Thursday) of this week.

Our Balanced portfolio consists of four components, Cash 3%, Fixed Income (5-7 yr US Treasury) 37%, Domestic Stocks (all US Stocks) 53%, and International Stocks 7%. Domestic stocks are the economic engine of this and all of our portfolios – period. Any positive contribution from Treasurys and International stocks is pure gravy.

Treasurys are included for their ability to act as shock absorbers, minimizing the emotional and economic damage stock volatility can cause. Their return from appreciation or interest is purely incidental. International stocks are included in our portfolios, not because companies based in Hong Kong are more profitable than those in the US (they are not), but because owning companies doing business in currencies other than dollars helps our clients preserve their purchasing power for imported goods (Toyotas and European vacations) in the face of a long-term declining dollar.

This week we saw stocks, domestic and international swing as much as 1.1% and 3%, respectively. Fixed Income, or US Treasurys moved as much as .5% in a day. For the week ended yesterday, stocks were down 1.26% domestic and 3.24% international, while Treasury’s were up .76%. This week Treasurys did just what they were supposed to do. They bounced significantly (despite rantings from market strategists to sell them in the face of impending interest rate hikes) to offset the losses in stocks. As a result, the Balanced Portfolio was down only .61% while its equity component was down a combined 1.4%.

The green line in the graph represents the Balanced Portfolio. Notice it is less wavy than the others, indicating less volatility. Also notice that it lies above the blue and the red lines, indicating better returns than two of the portfolio’s primary components – domestic and international stocks. The improved return of the portfolio is due primarily to the gold line above which represents the Treasurys’ top performance for the week.



An efficient well-allocated portfolio minimizes, to the extent possible, market volatility while still producing an attractive return. Market volatility is dangerous for two significant reasons. Large swings in people’s wealth frightens them and increases the risk they will make behavioral mistakes. And significant volatility reduces the probability of a portfolio’s meeting all of its planned requirements when big cash flows are coming or going. The reason here is that large cash flows, in or out, are more likely to occur at wrong moments if the frequency of wrong moments is high in a portfolio. A portfolio invested mostly in stocks or other very volatile assets is, by nature, going to have higher highs and lower lows and have them more often than more conservative, less volatile portfolios.

That the global markets carry a higher degree of uncertainty than usual is all the more reason to examine your portfolio for its risk and efficiency. And more importantly, it’s a very good time to assess whether you are taking more risk than is required to meet or exceed every goal you value.