INFORMED FOR LIFE - Advisor Products

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INVESTMENT The Importance of Reviewing Your Portfolio There are many lessons to be learned from the 2008-2009 financial crises. For individual investors, the most important lessons come out of a complex theory of investing called Modern Portfolio Theory. In its most basic form, this theory stresses the importance of diversifying your portfolio among different asset classes for safety. As the old saying counsels, “Don’t put all your eggs in one basket.” Unfortunately, diversification was proved not to be as effective as believed and the baskets failed many investors when they needed them to protect the eggs the most. Does this mean that we should abandon the theory of diversification? Absolutely not! Diversification has been useful over the long term. But investors may need to find another way to protect portfolios from the short term shocks. Investors need to recognize the value of diversification and, at the same time, compensate for its weaknesses. However, diversification is still an important first step in the investment process. So how can investors overcome the shortcomings of diversification and protect their portfolios from major downturns of the market? Large institutions such as pension plans and insurance companies have been employing downside protection strategies in their own portfolios for years. These are tools that attempt to bring more certainty to the investment process and can help stabilize a portfolio during market volatility. While the relationship between stocks, bonds, real estate, and alternative investments can change dramatically over time, there are other investments that have an opposite relationship to stocks. By allocating a portion of your portfolio to these tools that historically move opposite to stocks, you can help ensure that something within your portfolio is always working toward your goals. Unfortunately, many of these tools have not been easily accessible for the individual investor, until now. Employed correctly, these tools are designed to reduce risk compared to a portfolio not implementing any form of downside protection strategy. This results in a portfolio with much less volatility and downside risk, but one that keeps most of the upside participation intact. To many investors, the math of portfolio returns is not as simple as it seems on the surface. If your portfolio declines by 20%, you need more than 20% to recapture all your losses. Actually you would need a 25% return to get back to the breakeven point. If your portfolio declines by 40%, you need a return of 67% to get back to 4 www.rpgplan.com Continued on page 5
INVESTMENT The Importance of Reviewing Your Portfolio Continued from page 4 breakeven. And if your portfolio matched the 56% decline of the S&P 500 during the crisis, you would need a return of 127% to get back to pre-crisis levels. How many investors have the time and the courage to sit around and wait for their portfolios to recover from such devastating losses? The chart shows the cumulative returns necessary to break even when an investment loses value. If your portfolio is down 50%, you need a return of 100% to get your portfolio back to where it was. Of course, achieving that return is highly unlikely. Initial Investment: $100,000 Examine the chart’s different returns and appreciate how long it takes just to break even. Years Needed to Break Even at These Rates of Return If your portfolio is down... Current value Amount needed to break even Return needed to break even 2.00% 6.00% 10.00% 12.00% 10% $90,000 $10,000 11.1% 5.32 1.81 1.11 0.93 20% $80,000 $20,000 25.0% 11.27 3.83 2.34 1.97 30% $70,000 $30,000 42.9% 18.01 6.12 3.74 3.15 40% $60,000 $40,000 66.7% 25.80 8.77 5.36 4.51 50% $50,000 $50,000 100.0% 35.00 11.90 7.27 6.12 This highlights the importance of controlling risk in your portfolio. If you can reduce the downside exposure and limit losses when the markets decline, you will be in a much better position if and when the markets begin to recover. By losing less on the way down, you don’t have as much to make back on the way back up. By limiting risk, a downside protection strategy can not only give you a more comfortable path of investing... it will give you a much greater chance of success over major market cycles. Many people take steps to protect themselves from catastrophes. People insure their homes from fire and flood, their cars from the inevitable fender-bender, their health from the flu and major illnesses, and their lives to ensure their spouse’s financial security or provide for their children’s education. But when it comes to investment portfolios, which in many cases are the largest and most liquid components of an investor’s net worth, many forge ahead and subject themselves to the whims of the market. There is a better way. Please don’t continue to leave your portfolio unprotected. There are strategies available that are designed to help protect your portfolio in times of market volatility, Please consider if they are appropriate for you. 1 Call us to learn more about these strategies! 1.800.596.0253 www.rpgplan.com 5
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