Positioning Your Portfolio for Tough Times

The worst decision investors can make is to bail from stocks at the bottom, so knowing your tolerance for pain when setting asset allocations is the key, financial planners say

By David Bogoslaw

When looking at an equity market that's already lost 20% of its value from its highs last October, it's a little late to be thinking of defensive measures for your portfolio's asset allocation, says Paul Baumbach, wealth manager at Mallard Advisors in Newark, Del.

The best time to bulletproof your portfolio, he says, is during times of average or overpriced stock valuations. At this stage of the game, a more productive move by investors would be to take time to assess their actual exposure to further market declines. By getting a handle on their true exposure, investors can avoid getting overly emotional and pulling out of an asset when it's at or near bottom.

"Being human is the worst disadvantage we have as investors because the heart is telling you to do things that the head says not to do," Baumbach says.

Down times such as these can also be instructive for making allocation decisions in better times ahead, he adds. He might urge clients to write down how they're feeling about their portfolios now, put the paper in a sealed envelope, and revisit it two years from now once the market has rebounded and they're feeling more confident about aggressive investment vehicles.

"If any investor is saying, 'I want to pull money out of stocks,' he's also saying he had too much invested in stocks to begin with," Baumbach says. He tells clients to identify their panic point—the maximum exposure to U.S. stocks they feel they can stomach in a falling market—and then structure a portfolio to stop short of that threshold.

Too Much Company Stock

The single biggest mistake investors make is over-reliance on their own company's stock, according to Mark Congdon, a retirement specialist and senior partner at the Horizon Group in West Henrietta, N.Y.

Congdon says he read the riot act to a 55-year-old client who accepted a buyout package from a big manufacturing firm and had more than two-thirds of his net worth tied up in company stock. "No more than 5% of your portfolio should be in your company stock," he says.

Jeffrey Camarda, chief executive of Camarda Financial Advisors in Fleming Island, Fla., cites a woman who inherited $800,000 worth of Merck (MRK) stock. When he told her to sell it down, she resisted, only to have to dispose of it later for just $100,000 after the shares had been pummeled by a deluge of bad news involving its painkiller Vioxx.

Generally speaking, Mallard's Baumbach suggests two-thirds of your equities exposure be in U.S. shares and one-third in foreign stocks, but says that allocation should shift more toward non-U.S. assets over time as China, India, and other countries become bigger contributors to the global economy and America's role diminishes.

Of the U.S. portion, roughly 65% should be in large caps, 10% to 15% in small caps, and the remainder in midcaps. The balance among value, growth, and blends of the two should be based on what's occurring in the markets at any given time, Baumbach says.

Asset Allocation Strategies

Zero or low correlation between various asset classes is the hallmark of a defensive asset allocation strategy. That's not as easy to achieve using foreign stocks as it was before globalization started pulling all developed markets in roughly the same direction. While non-U.S.-based multinationals such as Unilever (UL) have a place in global stock funds, Baumbach prefers international small-cap names that would be unknown to most U.S. investors and are much less vulnerable to an economic downturn in the U.S. He gets these through the Artisan International Small-Cap Fund (ARTJX), which was down 22.4% year-to-date as of July 30 and is closed to new investors.