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Better Questions to Ask

As we near the end of 2013, the U.S. stock market is up nearly 28% for the year. This sharp rise has caused many people to become obsessed with “keeping up with the Joneses,” taking a near-term, relative view of their portfolios and asking how much higher this trend can go. However, that is a misleading question to ask. Instead, as a recent Wall Street Journal article suggests, a better question investors “need to answer is this: How much can I stand to lose before I will bail out?”

This is the basis for Balentine’s risk-first approach to investing. Our mission is to meet our clients’ goals taking the least amount of risk required. We strive to accomplish that by constructing portfolios based on the two most important things we can control: risk and liquidity. Every year we publish our Capital Markets Forecast. In this forecast, we look at what prospective returns are realistically possible from over 30 asset classes over a full market cycle. By grouping these asset classes into building blocks, we design strategies that are designed to generate a margin over a minimum real rate of return over a full market cycle given the likely peak-to-trough drawdown clients are willing to tolerate given today’s starting point. In addition, we rebalance tactically and use a combination of active and passive management to bridge the gap from these minimum real rates of return (what is possible) to the target rates of return clients require.

Another critical component is cash management. By keeping ample cash and cash equivalents on hand, we ensure that in the event of a drawdown, an investor should not have to draw on capital at temporarily depressed levels to meet spending needs. This helps investors avoid permanent impairment of capital. The question quoted earlier from “Do You Dare Buy Stocks at Record Highs?” misses a key point: sometimes it is not whether or not you choose to bail out; it is whether you are forced to bail out by spending needs. That is why liquidity is separate and distinct from drawdown risk.

The bottom line is, as we have learned from many previous market cycles, investors cannot control where the stock market will go; however, investors can control both risk and the liquidity profiles of their investments. Therefore, as the year comes to a close, rather than asking what return the stock market will deliver in 2014, investors should ask themselves these questions:

• What are your investment goals?
• How much risk are you willing to bear and how much liquidity do you need to stay on track?
• What else can you do to narrow the range of expected outcomes?

A focus on these questions will translate slow and steady returns into impressive long-term results that not only meet objectives but far surpass what the stock market alone can deliver over the near term.

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