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Portfolio Strategies during Periods of Market Volatility

Sigma Investment Counselors

September 22, 2011

During times like these we are often asked what we are doing to protect the value of our clients’ portfolios. This is a fair question and one that deserves an answer.

From a macro perspective, we take the time to understand each of our client’s risk tolerance, time horizons, income needs, etc. This information leads us to determining an appropriate asset allocation for each portfolio. In the simplest of terms, for accounts that will not be invaded for many years, we often have a higher concentration of stocks. For accounts where there are regular withdrawals, we want to have a sufficient % of the portfolio invested in cash and fixed income securities (bonds) to provide ample liquidity over a multi-year period to satisfy these future distributions. If one’s asset allocation is properly constructed, the portfolio should be able to withstand these periods of extreme volatility.

However, we now live in a digital world where an increasing number of individuals can and do keep track of the broad market averages and individual holdings on a continuous basis, using their iPhones and other mobile devices. Moreover, television channels such as CNBC, CNN, Fox News, etc., provide ongoing commentary as well, often sensationalizing the news to attract viewers. In my opinion, the thirst for such information leads to a greater emotional reaction to market swings, and leads to even greater market volatility.

For some investors, the tendency is then to micro-manage their portfolio, seeking to sell when the markets are falling and buy when the market is rising. This is known as market-timing. Other strategies might include the use of put or call options and/or stop loss orders to minimize losses. In other situations, investors may flock to “structured products” which attempt to limit downside risk in a security but allow for upside participation if and when the market improves. And of course, the investment in gold and other precious metals has also been popular as of late. Unfortunately, each of these strategies involves risks that are often overlooked and not fully understood by the investor. As a result, an investor may adopt what he/she believes is a conservative investment strategy and actually, may be introducing even more risk.

My colleagues and I meet on a daily basis to discuss the capital markets and we are vigilantly on the lookout for investment strategies where we can better manage the risk in our clients’ portfolios. Oftentimes, our approach looks to be fairly subtle, such as introducing a high dividend yielding stock or ETF in a portfolio in lieu of a lower yielding security. Our fixed income portfolios tend to favor investment grade securities with short to intermediate term durations. The introduction of TIPS in select circumstances has proven to be quite successful. Yet, these tweaks to a portfolio are not going to entirely protect the portfolio from major market moves.

If we felt that we could consistently employ these other strategies to benefit our clients, such as market timing, buying put options, chasing structured products, investing heavily in hard assets, etc., we would not hesitate to do so. Yet, the collective experience of our firm agrees, the odds of success are quite low utilizing these strategies.

In hindsight, where one has 20/20 vision, there are clearly those investment professionals who take a major bet on the market and prove to be correct. What is interesting, however, is that such success is hard to replicate through multiple market cycles and in fact, some of the best strategies in one cycle tend to be the worst strategies in other cycles. Thus, we advocate keeping a steady hand at the wheel, ride through these storms, make strategic tweaks as deemed appropriate and focus on the appropriate asset allocation over the longer term. Moreover, we would encourage investors not to be overly consumed by daily market gyrations, particularly if such behavior leads to emotional distress and short term irrational decision-making.

As always, we appreciate your thoughts.

Sincerely,

Chris Kress`

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