Should you be bulletproofing your portfolio for
wartime?
That’s
the recommendation of some “investment advisors,” and some investors are
listening. But it’s not a good idea, caution CERTIFIED
FINANCIAL PLANNER™ professionals, who believe that fear should
never drive investment decisions.
In the aftermath of September 11, military strikes
in Afghanistan, the Israeli-Palestinian conflict and the threat of war
with Iraq, suggestions for defensive “war” portfolios have begun to
appear. While these portfolios vary, they generally follow similar
investment advice: load up on defense-industry stocks, gold, and U.S.
government securities. Some recommend oil stocks on the premise that a
Middle East war will dramatically push up the price of oil. Others like
the stocks of companies producing products that consumers will buy
regardless of the circumstances: food, tobacco, medicine and so on.
One defensive war portfolio found on the Internet
calls for 70 percent U.S. Treasury securities and certificates of
deposit, 10 percent precious coins, 10 percent defense-industry stocks,
and 5 percent each of Swiss francs and New Zealand dollars. If disaster
really does strike, some would argue that this would be a sound
portfolio. But one of the problems, point out others, is that this
particular “war” portfolio has been recommended for the past six
years—the first four of which saw record stock market growth.
It’s the same principle as having a very defensive
portfolio whose asset allocation mix is always braced for a market
downturn, say planners. Yes, markets periodically falter, as they have
the last two years, and a conservative portfolio might serve you well at
that point. The problem is that we rarely can forecast a market downturn
and in the meantime we miss out on the growth, which, over the long
haul, has more than overcome the downturns.
Does the idea of a defensive portfolio sound
familiar? Go back to the fall of 1999, when alarmists warned of the
impending Y2K disaster and some panicked investors converted all their
investments to cash, often with significant tax consequences and missed
market returns.
Unlike the Y2K scare, terrorism is real. But war has
hit Americans before, and in most cases the economy and the stock market
have weathered them well. The S&P 500 was up 20 percent within one year
after Pearl Harbor, for example, and the Dow climbed 20 percent two months
after the start of Desert Storm.
Although most investors will maintain their current
portfolios, some panic and switch from long-held asset allocations to
these war portfolios. Other investors have hunkered down with a lot of
cash, though other factors such as the economy, Enron and the continued
whipsawing of the stock market have contributed to their nervousness.
The smarter move, say planners, is to stick with a
portfolio that’s well diversified and that reflects your long-range
financial goals, risk tolerance and personal circumstances. You should be
investing only for the long-term, such as for retirement and college, and
not let potential catastrophes—whose dimensions are unknown and which
could affect portfolios in unforeseen ways—dictate your portfolio’s
makeup.
A disaster-driven portfolio is usually an extremely
conservative one, and as a consequence, investors following them are more
likely to fail to reach their financial goals because of inferior
long-term returns than because of shorter market declines due to a
disaster, argue most planners. Besides, they say, if a national
catastrophe were to strike that truly crippled our nation—devastating
terrorist attacks or a nuclear attack, for example—even a “war” portfolio
would unlikely be of much value in the aftermath.
For those investors who still feel defensive about
their portfolio, some planners recommend tips that can help but not hobble
the overall portfolio too much. One suggestion is to designate perhaps ten
percent of the portfolio to a defensive position, such as U.S. Treasuries,
precious metals, cash and real estate. Another is to buy certificates of
deposit from financial institutions located in different geographic areas.
But ultimately the best defense, say
most planners, is a well-diversified portfolio that over time will perform
satisfactorily regardless of the circumstances. A portfolio that holds
foreign stocks and foreign bonds, for example, which many planners
recommend under normal circumstances, could help blunt the effects of
damage to the United States.
E-mail this story to a friend
June 2002 — This column is produced by the Financial Planning Association, the
membership organization for the financial planning community.
