Insure Your Portfolio against Black Swans

 

September 8, 2016

 

JER WW PHOTOClients—usually new ones, for a reason I’ll explain below—sometimes contact me after a major, unexpected global news event. They want to know how it will affect their investments, and whether changes are needed in their portfolio.


My response is to advise calm, not because the event in question will not impact the investment markets, but because their portfolio already has a kind of built-in insurance against such things.


What is a Black Swan?


Remember Brexit? The night before the referendum on whether the UK would stay in the European Union, the polls and pundits said the “Stay” side would win a narrow victory. Instead, the British people voted to “Go.” Significant market turmoil followed.


Remember the Arab Spring? It began when a Tunisian street vendor, fed up with municipal authorities who confiscated his products, immolated himself in protest. Who could have predicted such a thing? And once the movement was underway, spreading from nation to nation, remember how many media pundits hailed it as a new dawn of freedom and democracy in the Middle East? That prediction also turned out to be off, or at least premature. Today the region is as chaotic as ever.


Because geopolitical shifts like Brexit and the Arab Spring are so unpredictable, they are sometimes called “black swan events.” Their appearance is rare. But once they arrive they can have a large impact on stock markets. How can we as investors be prepared?


One good way is through diversifying our portfolios geographically.


There is a wide world of equity opportunities out there, easier than ever to invest in. In fact, there is now almost as much stock market capitalization outside the U.S. as within it. We are talking about a non-U.S. investment space of over 10,000 firms in some 40 countries. Diversifying across this lets you access new opportunities for superior returns, while also protecting against black swan events that generally hit one region much harder than others.


Think about the Great Recession that began in late 2007. That was a black swan that had very deleterious effects on U.S. stocks. The total return of the S&P 500 for the ten-year period 2000-2009 was -9.1%, its worst decade showing in history. But during that same timeframe, some other parts of the world fared much better. Emerging Market stocks, in particular, experienced tremendous returns.


In the years since, the opposite has generally been the case. U.S. stocks have outperformed most other parts of the world. That’s diversification at work. It lowers your risk because when one region is down, others are likely to be up. It’s why investors who are globally diversified have much less to fear from black swans.


And it’s also why new clients are usually the ones who contact me after a major news event. They are still adapting to our approach of taking the risk and guesswork out of their financial situation, through such things as geographic diversification. Our ultimate goal is to help you relax and be free to focus on living your life. It’s what we’ve been doing for over thirty years. To learn more, please contact Jim Waters, CFP®, at 713.964.4028 or jrw@partnersinwealth.com.