Keep emotion in check, portfolio balanced

“During periods of maximum stress, your emotions can trump logic, and tend to trump rational decision making,” he said. “You get to a point, for example, when you’re down 40% or 50% for example, and you say…I can’t take it any more; I just need to get out with what I have.”

Investors typically are hardwired to try and cut their losses when they fail to see a bottom on a market collapse. There is very little experts can do to bring them back from the brink. The opposite happens when the stock market is flying and investors start to put money into the market.

“It’s one of the few commodities where people want more when prices are high and less when prices are low.”

The lambda of a sinusoidal wave of investing emotions goes from optimism to euphoria and dives to despondency before rising back to optimism.

“That’s something that’s manifested itself over and over again, and it’s not unique to retail investors or institutional investors, or professional investors, everybody sort of behaves in a pretty similar manner with very few exceptions,” said Beckerleg.

Rearview mirror investing hamstrings investors who extrapolate future returns on the basis of past performances. Beckerleg chalks it up to hardwired human reaction to things. “It’s very hard to be outside of the herd, to sort of run beside the herd, rather than in the warmth within the herd.”

Rational decision making thus becomes the first casualty. Although he admits panic selling at the bottom is not necessarily irrational but just an unfortunate position to be in. And that, he said can be helped, by creating a framework where investors don’t need to react. Or react in the opposite way to what most people are doing.

“Outline a reasonable framework strategy for how to make asset allocation decisions,” he said. “They’re going to be particular to each person, but the point is that if you stick to the path the hope would be that over a long period of time you can make the right decisions for your situation at the right time.”

When the chips are down, holding cash, as many are wont to, hasn’t been a winning solution. “You can’t just hold cash as a solution.”

The maverick investor – he’s 100% stocks – dismissed buy and hold as “not really an asset allocation strategy,” choosing to focus on the other two asset allocation strategies, strategic and tactical.

Of particular focus was strategic asset allocation, which he defined as rebalancing to a long-term asset allocation that reflects investors’ risk tolerance and return objectives.

“What that simply means is, I’m going to put 60% of my money into stocks, 40% of my money into bonds, and periodically, whether it’s every six months or every year, or every time the portfolio goes out of whack by 5%, I’m going to make adjustments to my portfolio to bring it back into line with that 60-40.

“And I’m not going to change that 60-40 mix depending on whether I think stocks are better than bonds or bonds are better than stocks, or international is better than U.S., or U.S. is worse than Canada. I’m setting out a plan and I’m sticking to it.”

This means every time it falls out of whack, bring the portfolio back to that plan, because it meets the client’s near and long-term goals.

Tactical asset allocation, on the other hand, is the exact inverse. Beckerleg likens it to trying to time the market as it appears on the television screen. “This is a management strategy that involves allocating investments to take advantage of perceived pricing anomalies and strong market sectors.

“But it’s basically trying to identify the best asset class at all times, and put your money, or move your money out of different assets and into that asset. And that’s what you hear about obviously on TV.”

People, he said, are focused on tactical asset allocation because the rewards are tremendous. “If you do get it right you can make an absolute fortune,” he said while adding that things could just as easily go pear-shaped leading to a distressing outcome.

He also took a swipe at financial institutions and the media over their claims about having all the answers. “There’s the influence of financial institutions trying to encourage you to transact and make decisions, because that’s how they make money,” he said. “There’s definitely the influence of the media; I think the media influences all of this.”

People get tempted because the rewards are tremendous, he added.

Strategic asset allocation, conversely, shuns the mercurial and myopic nature of tactical allocation. “[It is] rebalancing to a long-term asset allocation that reflects your risk tolerance and return objectives [while] constantly rebalancing to that portfolio mix, regardless of what you think is going on in the market,” said Beckerleg.

Strategic asset allocation changes with time and personal circumstances rather than responding to the vagaries of stock market. “As you get older [and] if your earnings power starts to diminish over time, you probably want to move to a more defensive posture, assuming that you need some of the money to fund your lifestyle.”

The first step in the process is understanding one’s financial standing, in terms of assets and liabilities. And for that, he said, one needs to look beyond their portfolio. “Your assets are not just your portfolio [but] what we call human capital; it’s your income stream.”

A steady income by way of a pension can be a significant asset and must be taken into account when planning out lifestyle. “Depending on your age, obviously, your human capital changes over time, because you get closer and closer to retirement.”

Then, comes a long hard look at one’s liabilities – mortgages, loans, tuition fees – not to speak of some discretionary wealth and mattress money. “The important thing is, these liabilities have to be matched with assets and goals that make sense against those liabilities. And that’s where a financial advisor can definitely help you.”

Finally, he stressed the importance of knowing your risk tolerance and being realistic about it. “We need to be realistic about the fact that over the next five to ten years [we] don’t want to put the house at risk, [or] put our kids school education at risk.”