Are you prepared for the future?

By Tom Anderson / Guest Editorial

In my past two Corridor Business Journal columns, I’ve addressed the need to understand that the past 30 years of economic history in the United States cannot repeat itself.

Investors must not use this time period as the basis for investment decisions. Additionally, a review of the fiscal cliff and a “stress test” of the economy revealed that some of the biggest buyers of U.S. treasury securities are becoming sellers, leading us to imagine the possibility of increasing interest rates.

In light of these points, investors should position their portfolios for the different potential environments we could face as a result of this knowledge by addressing five main points:

1. Embrace a goal-based approach to asset allocation and get your account structure right

2. Play both offense and defense

3. Reframe your view of the world and eliminate “home bias”

4. Proactively stress-test your portfolios and examine your debt ratio and debt strategies

5. Include “anti-fragile” characteristics in your portfolio

My first recommendation to investors is to embrace a goal-based approach to asset allocation and get your account structure right. Investors have three objectives: “safety” is measured as keeping pace with inflation, “core” is measured as inflation + 4 percent returns and “tactical” is for the assets investors have with which they are willing to take on more risk for the potential of more return.

At a minimum, I recommend that U.S. investors have a three- to six- month cash reserve for emergencies. Any additional cash needs for the next year should also be in cash. Any financial needs over the next five years should be invested with “safety.” From here, I recommend that you work with your financial advisor to examine your needs and risk tolerance in order to determine the right weighting between “safety,” “core” and “tactical.”

I have spent an extensive amount of time creating a “risk dashboard” that enables our team to make proactive investment changes by utilizing the latest technology to accomplish precision investing, account-level defined objectives and dynamic rebalancing. None of this is possible without the right account structure. Assets should be held in an integrated account where the manager is able to do all of the aforementioned. Each of our portfolios is dynamically rebalanced based on its stated goals and the relative movement between asset classes.

I’m not advocating that investors “go to cash,” and likewise, investors should not “put all of your money in bonds.” There are instances in history of investors who have held $20 million in bonds only to find these bonds to be worth only $6 million, virtually overnight. I constantly test each of the tenets of how we model and what shapes our perspective.

Just as important as it is to test for the downside, investors must be positioned to participate in the possibility of continued upside in risk assets. Investors must play both offense and defense to win.

Investors must also be cognizant of home bias, the process of overweighting one’s home country in asset allocation. It is a major flaw in most portfolios. Although it is an extreme example, Greece illustrates the pain of home bias. It didn’t matter if a person held 60 percent Greek stocks, 40 percent Greek bonds or 40 percent Greek stocks, 60 percent Greek bonds. Size, style, and company selection were of little relevance. What mattered was how much the investor had in Greece (or, actually, how much the investor had outside of Greece). Not surprisingly, I typically see that U.S. investors have about 85 percent of their money in the United States, denominated in U.S. dollars. I recommend a world neutral asset allocation.

Recalling the message of my first column – the next 30 years cannot be like the past 30 years – investors must continually evaluate the world and the asset classes they choose to hold. Pro-active stress tests have led me to sell 100 percent of U.S. corporate, high yield and municipal bond positions in my “safety” and “core” portfolios. Additionally, I have sold all of our long term treasury bonds and materially trimmed intermediate treasury and TIPS exposure within these same portfolios. Investors who continue to hold these asset classes need to consider both the fundamentals and the supply-and-demand characteristics over the next five years. Although real estate is a part of our “core” portfolio, it has been trimmed back due to recent gains. The debt investors maintain also needs to be carefully examined and shocked against multiple scenarios.

Finally, it is imperative that an investor’s strategy include “anti-fragile” characteristics. Nassim Taleb coined the phrase “anti-fragile.” Anti-fragile is something that thrives and grows when exposed to volatility, randomness and disorder, and actually becomes stronger as stress is applied. This concept can be expressed in investing. In these times, there are some assets that should be held for their anti-fragile characteristics.

This is a very complicated world. I encourage you to challenge your portfolios by stress-testing them. Similarly, it is beneficial to challenge your advisors; stress-test them, too. It is imperative to ask tough questions, expect detailed answers, and most importantly, don’t be surprised by (or unprepared for) what the future brings.


Excerpted and adapted with permission from The Value of Debt: How to Optimally Manage Both Sides of a Balance Sheet to Maximize Wealth by Tom Anderson, to be published by Wiley in September.


Tom Anderson is an executive director-wealth management, a senior portfolio management director, a family wealth director and financial advisor with Morgan Stanley.