How To Avoid A Market Decline Like Yesterday – Part I

The broad equity markets experienced a sharp selloff yesterday (Feb 27th).? It was the largest point decline since 9/11 which brings up the question of how you protect your investments in such an environment.? To give you a reminder of what happened yesterday:

• 95% of the S&P 500 stocks were down on record volume in the NYSE.
• All 30 Dow Jones stocks were down.
• The China equity market fell 9%.
• Dow dropped 415 points and was down over 525 points intra-day.
• Nasdaq ended the day down 3.9%.
• All gains in 2007 were erased in 1 day.

After a day like yesterday, the question becomes “How do you avoid losing money in a decline?”? The answer to this question is probably not one you want to hear because it revolves around a strategy which is aimed at making 8-12% annual returns regardless of market conditions; more commonly referred to as an absolute return strategy.? To give an example – if the market drops 25%, your portfolio should still make you money.? If the market runs up 50%, your portfolio will not match the 50% return but will still make you money.? People make the mistake of thinking they can get the best of both worlds in that they will match a huge run-up in the market AND avoid a large decline.? You cannot have both, so the way to protect against a downturn is as follows:

Diversify Beyond Equities.

People think if they diversify between large cap, mid cap, small cap, value, and growth stocks?that they are diversified.? That is not true. All these investment classes are highly correlated and tend to move in similar directions over the longer term.? True diversification means to find NON-CORRELATED investments.? The real asset classes you should invest in when looking for true diversification are

1. U.S. Equities
2. International Equities
3. Fixed Income
4. Real Estate
5. Real Assets aka Commodities / Metals
6. Private Equity

These asset classes are true non-correlated investing.? Most of you are thinking, ‘how does the average person without millions of dollars invest in these asset classes?’? I’ll tell you in part II.

I bet most of you thought every investment?lost money yesterday.? This chart shows a few of the above asset classes performance on February 27th.? As you can see, some made money.

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