I’d like to address our response to the recent volatility in worldwide markets. Since the market crash in 2008, there has been an increased focus on using alternative investments as a vehicle for providing added diversification to a portfolio. In fact, you may have seen past articles in the KMS client quarterly. Alternative investments include asset classes outside of your traditional investments (stocks & bonds). Alternative investments include commodities, gold and other precious metals, currency, Real Estate Investment Trusts, and managed futures. Since these asset classes have a low correlation to traditional investments, they can help diversify an account and lower a portfolio’s overall risk. Low correlated asset classes typically don’t move in the same manner from one day to the next. As an example, the price of gold might trend up on a day when Largecap U.S. stocks are trending down. Historically, when alternative investments are added to a traditional portfolio the overall volatility has decreased and the returns have increased. (Lower Risk / Higher Reward).
Let’s take a quick look at a case study. Suppose you invest $100.00 into two separate portfolios, and hold the investments for three years. The returns for each of the two portfolios are listed below:
Year 1 Year 2 Year 3 Portfolio Value after three Years
Portfolio A: 20% -30% 40% $117.00
Portfolio B: 8% 8% 8% $125.00
As you will note, Portfolio B had a much more consistent return over the three year period averaging 8% annually. The average annual return for Portfolio A was 10% annually, but there was far greater volatility. As you will note, Portfolio B had the highest value after the three year performance even though it had a lower average annual rate of return. The reason for this discrepancy is that large losses will need a much greater return to get back to the original value. (If you lose 50% on a $100 investment, your account will be valued at $50.00. Now, you will need a 100% return on the $50.00 in order to get back to your original $100.00 investment.
The illustration above should help explain the need for lowered volatility in a portfolio. The use of alternative investments in a portfolio can help your returns look more like Portfolio B (less volatile and more efficient). Today, we have access to many investment tools to get broad exposure to these various alternative investments. We have been recommending them in a number of accounts in order to help stabilize returns during this choppy market. If you are interested in finding ways to add them to your investment portfolio, please give us a call anytime.