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European Credit Crisis: What to do Now?

by Ram Balakrishnan
August 8, 2011
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In past market downturns, I’ve always maintained that an investor should stay the course, as long as she has a suitable asset allocation that she is comfortable with. Even though markets have been losing big chunks of their value seemingly every single day, the mantra remains the same: hold the course.

However, a number of investors are unfortunately finding out only now that their asset allocation was far too aggressive. What should these investors do?

The answer is easy for investors who find that they have an asset allocation that is inappropriate for their financial goals. For example, an investor who finds that the education savings of their child who is attending school pretty soon is mostly invested in stocks should take action now. She should reduce the risk of the portfolio right away by selling some stocks and parking the proceeds in savings accounts or cashable GICs. For all we know, it could get a lot uglier and it may be better to take the lumps now and preserve whatever capital is left.

It is harder to think of a suitable course of action for investors who have the ability to take risk but are only now finding out that their risk tolerance is a much lower than they had earlier estimated. There are no easy choices. They could sell some stocks now but they may be locking in their losses but selling may also mean that they don’t take an even more drastic action should stocks fall even more. Or they could resolve to reduce risk at the first available opportunity and plan to endure the current downturn. The obvious risk here is that things get a lot worse and they sell at an even worse time down the road when they feel they can’t take the heat anymore.

Personally, I’m opting to hold the course. My rebalancing spreadsheet indicates that the bond portion has increased to 2.5% of the portfolio. If current trends continue, it will soon be time to sell some bonds and buy some stocks. Until then, I’ll just be content to watch the horror show on Bay Street from the sidelines.

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