Are You Swimming Naked?

In a rising market, every portfolio appears solidly built. You only find out if you’re swimming naked when the tide goes out, as Warren Buffett famously said.

From March 2009 to August 2012, the Dow Jones Industrial Average has almost doubled from roughly 6,500 to 13,300 and almost everyone holding stocks has made money.

But good investment results, even over a few consecutive years, do not imply that you have a sound investing strategy going forward. The rising market tide over the past few years may have lifted your portfolio, yet your portfolio could suffer deep losses should the market reverse or crash… and that would be the equivalent of swimming naked. It’s best that you stress-test your portfolio now and re-balance it while it’s up so your it doesn’t get caught with its pants down should the market recede, as Buffett implies.

A sound investment strategy should be based on your near-term and long-term financial goals, should not be overly tied to the market, should balance risk and reward, should help you reasonably outperform inflation, and ideally beat the market when it is down. Such portfolios may also lag the market in overly bullish times such as when bubble-like sentiments take over – and in such times, it is your job to be stoic and not do anything that hurts you in the long run.

While most individual investors think they’re pretty smart and understand the risks and rewards of investing, let’s face it… most of us just do not have the financial, accounting or math background… or the time, discipline, patience and mental mindset to truly research the risks and rewards of stocks, bonds, commodities, currencies, real estate, and everything else that goes into building and maintaining a truly diversified portfolio. Most individual investors just do not dig deep enough before they buy or sell securities. They buy mostly on hearsay and, at most, after reading a few research reports.

So most individuals are typically better served by acknowledging their shortcomings in making investments and letting investment experts guide them – because trained and experienced research analysts do this full time, with all the right tools, and access to the latest information through their grapevine which individual investors only hear of after the fact.

If you decide to pick a financial advisor, make sure he or she is backed by a solid company with dedicated teams focused on each major asset and security class, and can tap into sector experts and research resources to help you build a truly diversified global portfolio across all asset classes and investment types.

Don’t D-I-Y or Wait Too Long

Yet, unfortunately, too many folks wait too long before they even think of stress testing their portfolios, and often wait until after most of the damage is done. They then complain of not getting enough income from their portfolio, of messed up investments, depressed home values, sky-high credit card bills, and so on. Timing is everything, and for such people, there are fewer and fewer options left if they wait too long.

With investments, there is tremendous power in compounding, so the sooner you start the better. And the sooner you get your kids to start saving, prioritizing expenses, and investing, the better for them too.

Now’s a Good Time to Act

While the past few years have worked out well for US markets, everything that has happened in the world over the past few years does not bode too well – the Arab Spring’s ongoing rebellions to overthrow tyrants in Arab countries and setup new, yet untested, forms of governments; economic uncertainty in Portugal, Italy, Ireland, Greece, Spain and who knows where else; talk of an economic slowdown in China; high debt and unemployment here at home; the threat of a nuclear Iran; and the impact of all this on oil prices – all this threatens the U.S. economy and could well result in a market drop in the years ahead. Indeed, many market observers such as Peter Schiff and Dr. “Doom” Nouriel Roubini say a crash is definitely on the cards in the coming years – no one can predict quite when though. After all, the Dow has been rising relentlessly since 2009 and it’s only natural that strong global headwinds could give pause to investor optimism. Or, in the worst case, lead to yet another market crash.

So, at this juncture, investors must honestly evaluate their portfolios for downside risk and seek suitable investment alternatives should your portfolio be at risk. Make sure you are confident about your investments going into 2012 and beyond should the market decline or maybe even crash. It always helps to model out a few worst-case scenarios and see how your portfolio might perform. Most financial advisors have the tools to do this stress testing.

The tide may be changing. It might just be going out. Are you swimming naked? It’s time you found out.