How Solid Is My Portfolio Strategy Against Possible Crises?

I come across a lot of people willing to trying to setup an investment strategy, mostly for themselves and some for their businesses, and the most common question is: How Solid Is My Portfolio Strategy Against Possible Crises?

I have to say, I was a victim of that way of thinking, and one day when I was setting up an investment strategy for a new fund, it suddenly clicked: Am I really protecting myself against future financial crises?

You may come up with goals and strategies that ‘could’ potentially save you from crises, but the returns on the portfolio would be so low that may not break-even with the costs associated with the securities. Most of the time, people end up not going with the strategy, and not invest their money, lose-lose situation!

So what to do … ?

Let’s take a step backwards, what is a financial recession? The National Bureau of Economic Research’s (NBER) defines it as: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

Put it in simple terms: It’s a period of time where everybody from large corporations to the average Joe suffer economically.

Easily understood.. Now what should anybody do in a crisis time? Almost anyone can agree on the following two:

  1. Cut spending.
  2. Preserve cash, and be conservative with investments.

What essentially those two points say is that if you have a pile of cash sufficient enough to run your day-to-day life (or operations) for the period of the crisis, then you’ll be in a good shape compared to everyone else that doesn’t.

Now, let’s get back to our question:

How Solid Is My Portfolio Strategy Against Possible Crises?

The answer is: Not solid!

Instead you should be asking this: How Much Cash Can I Generate In Good Times To Sustain A Crisis, If Happened?

This way, you would design your investment strategy in a way to generate steady cash flows with adequate risk levels, knowing that if a recession happens, you’ll probably lose a substantial amount of asset value. But if you have generated good realized returns (e.g. dividends, bond returns) in good times, you won’t be pressured to sell your assets in a bad time, rather you can rely on your cash and survive the recession time, at the same time still own assets for after the recession ends!

Summary

  1. There is few or no cost-efficient way to hedge risks against crises when designing an investment strategy.
  2. Try to to design your portfolio in a way to generate adequate amount of realized returns in good times.
  3. In a crisis time, cut spending, survive as much as you can on your savings (if needed!), try not to liquidate your assets as much as possible, and be very conservative with investing.