Portfolio Management: Dynamic Asset Allocation


How do I grow my portfolio AND protect it?

We get it! You want to remain aggressive so you can grow your wealth and fund your retirement, BUT you can't risk another devastating bear market like the 2008 financial crisis. You need to maximize the growth AND protect your portfolio from protracted declines.

How do you accomplish both?


Bull and Bear Markets

The stock market goes through long-term positive trends (which we call secular bull markets) and long-term negative or flat trends (which we call secular bear markets). These time periods tend to persist for long multi year periods that often last 10 years or more. 

Unfortunately, you can do very little about the time period that you are born into or (perhaps more worrisome) the time period that you retire into. It would, of course, be ideal to retire just at the beginning of a massive secular bull market, but we can't control that. 

Then, we have shorter term bull and bears, which we call "cyclical" bull and bear markets. We've seen a couple of these over the past couple decades. Cyclical bear markets typically exhibit as massive downward movements in stock markets. The bear market of the early 2000's, following the tech bubble bust, and the financial crises of 2008 were both sell-offs of more than 50% in the S&P 500. 

The most dangerous thing for retirees is to experience one of these major stock market downturns near retirement or in the first few years of retirement. This reduces your portfolio value at a critical time and can dramatically reduce the odds of making it through retirement without running out of money. 

The Traditional Approach

The traditional approach to portfolio management suggests investors should simply "buy and hold" a diversified mix of different assets. This approach assumes that we cannot avoid market declines and that the best way to reduce the risk of market declines is having a fixed percentage of bonds in the portfolio to buffer downturns in the stock market. This approach also assumes that since we cannot predict which asset classes will be winners, we should own a broad mix of all asset classes.

We feel that this approach has major flaws and is inadequate for today's retirees. Here's why:

1. Bonds alone do a poor job of reducing risk.  While dedicating a certain amount of the portfolio to lower risk assets like high quality bonds can reduce risk of the overall portfolio, this often does not achieve enough risk reduction. A portfolio that is 60% equities and 40% bonds will still experience 60% of the equity market's risk. When we consider that stock markets can experience declines of 50% or more like they did in 2008, this still exposes the portfolio to a high degree of downside risk. Additionally, most people believe that when stocks go down, bonds will go up and provide protection. But history has shown this is not always the case. In fact, much of the time stocks and bonds are positively correlated--meaning they move in the same direction.(1) Furthermore, bonds have risks of their own including interest rate risk. Simply buying and holding a fixed percentage of stocks and bonds will not work effectively under all market conditions. 

2. Diversification does a poor job of reducing risk in extreme market events. Diversification assumes that you can reduce risk by spreading your investments among many different asset classes. This does reduce the risk of putting all your eggs in the wrong basket, but diversifying among all asset classes means that you will have some bad eggs in the portfolio. Research has shown that lagging asset classes tend to persist in underperformance while leading asset classes tend to persist in outperformance (1). In addition, during extreme market downturns, like the financial crisis of 2008, stocks tend to perform similarly no matter their asset class--and plunge together.

3. Buy-and-hold relies on having LONG time frames and ignores the potential volatility of the market. Investors near retirement don't have decades to invest. Markets can be very volatile over the short term. Extreme events are more common than we like to believe. To investors, even 5 years is a long time. But even over the course of 5 years, the market can be sharply negative. The S&P 500 has had 5 year periods with declines of more than 15%, and 10 year periods that ended more than 4% below where they started (1). A negative decade like that is disastrous to any retirement plan. 

Surely, there's a better way!


Our Approach: Dynamic Asset Allocation

Dynamic means "change." Rather than a static portfolio, we believe a dynamic and active approach to portfolio management can do better. Our approach is:

Research-based: Our investment process is based on research.  And research has shown that trend-following, tactical strategies can be far more effective in capturing market upside and insulating from market downside than traditional buy-and-hold strategies. Our investment strategies are built on thorough historical testing. Our strategies have historically shown the ability to perform well in both bull and bear markets and can outperform a "buy-and-hold" approach over a full market cycle.

Rules-driven: Our investment process is based on specific rules that we derive from data. We do not manage portfolios based on our opinion on where markets may be headed but on empirical data and probabilities.This removes the human emotional component from the investment process, which is often where investors go wrong.

Responsive: Our investment strategies are designed to adapt to market conditions--to be more fully invested during bull markets and to be defensive and protective during bear markets. Rather than being married to a fix percentage of stocks and bonds, our strategies are dynamic and adapt to market conditions--increasing exposure to stocks during bull markets and reducing exposure to stocks during bear markets. Many advisors counsel their clients to just "hang in there" when the market is tanking and do little to protect their clients. Our strategies are designed with bear markets in mind--with proactive measures designed to protect investors from major draw-downs.

For more information about our strategies, please send us a message or schedule a meeting with us by clicking the link below:






(1) Adam Butler, Michael Philbrick, Rodrigo Gordillo, Adaptive Asset Allocation (Hoboken, NJ: John Wiley & Sons, 2016).

Past performance is no guarantee of future results.