There is a simple litmus test to determine if your diversified portfolio will fail. Ask yourself the following questions.
- Do you understand every single investment in your portfolio?
- Do you know why you own every single investment in your portfolio?
- Can you confidently provide three excellent reasons why you expect to make money, above inflation, on every single investment in your portfolio?
If you cannot answer yes to all three questions, then you have a problem.
Do You Understand Your Investments?
If you don’t understand your investments, then you don’t understand how much you can lose. If you don’t know how much you can lose, then there is a very good chance that when the next recession arrives, you might lose a lot more money than you ever expected. If your losses exceed your expectations, you might panic and sell your investments at the bottom of a recession. The moment you sell your investments at the bottom of a recession, you might as well throw your retirement plan in the trash can.
Do You Know Why You Own Your Investments?
If you don’t know why you own the investments that you own, there is a strong chance that your investments are out of alignment with your risk tolerance, return needs and return expectations. You might have a nice pie chart for your investments, but if you don’t understand why, you own the different colors of pie, you have a problem. You are at a serious disadvantage.
Can You Give Three Solid Reasons Why You Expect to Make Money Above Inflation?
If you cannot provide three solid reasons why you own every single investment in your portfolio, then you don’t understand the investments you own and you don’t know why you own them. If you are not confident in the investments you own, why own them in the first place?
For example, in the pie chart below we see asset classes like Non-US Bonds, Real Estate and US-High Yield Bonds. If this pie chart was your portfolio, would you be able to provide three excellent reasons why you expect to make money, above inflation, on these asset classes?
Take the time to review your own pie chart and challenge yourself. How well do you know your investments? Now is the time to conduct this exercise when the market is up, and the economy is strong. Be prepared now for the next downturn, whenever it arrives, so you don’t get caught off-guard!
Ethan S. Braid, CFA
President
HighPass Asset Management