Survive and thrive in the coming market, no matter what happens.

For years when the market did nothing but go up-up-up I preached asset class diversification.  This didn’t mean stock and bonds.  This meant publicly traded equities, private equity real estate funds (not REITS), syndications, insurance products, cash etc….

Not a lot of people headed my warnings.  Heck, even I became complacent with the unceasing gains the market gave.  Unfortunately, the chickens seem to be flocking home to roost.  Rather than hit the PANIC SELL IT ALL! button pretty much all I am doing these days is helping my clients hedge against market downturns without giving up the potential upside of a rebound.

Most traditional ways of thinking about investing revolve around the 1:1 risk to reward paradigm.  But you can actually change the game by adding more reward without adding risk.  The chart below is a great example.  It shows the three basic ways to grow your wealth.

The Red Line:  These are traditional investments.  Stock market and real estate centric investments.  Everyone recognizes the .COM bubble burst of 2000, and the housing bubble burst of 2007.  It is a roller coaster, but over the long run has produced historically great returns.  The risk of having your money in the market changes over time.  As you get older you don’t have the time to recover from big downturns.  Note that from the top of the .COM bubble it was 14 years before the market “came back.”

The Blue LineThese are traditional fixed securities.  Bonds, CDs, promissory notes etc…  These pay a pre-determined amount based on the institution that issues the security.  What a lot or people don’t understand is that, even though the rate is typically guaranteed, the price of the security itself can fluctuate.  I.E. If you own a bond purchased 2 years ago that is paying 2.5%, you could not sell that bond today for what you paid for it, you will take a loss, because people can now purchase bonds paying 5%.

The Green LineThis is essentially a hybrid of the two different types of securities.  The companies that issue these products take your money and buy a bunch of the BLUE securities, but then also manage a portion of your money using options to the stock market.  This means if the market is up, you can make market like returns.  If the market is down, you lose nothing.

The big question is this:  What will the market do in the next day/week/5 years.  The answer is NOBODY KNOWS.  Not the talking heads on CNBC, not the guys on the internet forums, not me, not anybody.  Do not trust anyone who says otherwise.

What I do know is this.  A properly built portfolio can both flourish when the market is good and be less painful during times like these.

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