The question seems simple. "How's my portfolio doing?" The answer isn't so simple: "Compared to what?"

The question seems simple. “How’s my portfolio doing?” The answer isn’t so simple: “Compared to what?”

The response might launch one into a discussion of comparative risk based on a variation of an ancient vaudeville joke. Q. How’s your spouse? A. Compared to what?

A funny thing happens as one retires. Before retirement, when you receive a paycheck on a regular basis, you are content to let your 401(K) plan or other asset accumulation vehicles generally roll through the ups and downs of markets. When you retire, you watch your portfolio more closely, as you miss regular paychecks hitting your bank account like clockwork. As advisors we counsel a “paycheck fund,” enough liquid and low risk assets, and perhaps cash-flow producing alternative investments, to fund a monthly “paycheck,” a reserve, that can power 3 to 5 years of “paychecks” before you have to sell stocks to run your life. But you still watch the market and wonder, “How’s my portfolio doing?”

You go to a fine restaurant with five other people and pour over an extensive menu. You finally make a choice. When the meals are presented, you cannot resist looking at what the others ordered, wondering, “Did I make the best selection?” On a comparative basis, once you see the outcome of different meal selections, you may feel that you could have made a better choice.

You meet with an advisor to design a portfolio. You are conservative. Not too much risk. On the menu you see “value defensive stocks,” the least volatile option, and “growth dynamic” stocks, the most volatile selection. While you might mix in a bit of both, you more heavily weight value stocks, “steady Eddie” type companies, generally with good dividend yields. Later, after some time passes, you ask, “How’s my portfolio doing?” What will you compare it to?

A July 2015 commentary from Atlanta-based money management firm Equity Investment Corporation (EIC) illustrated the conundrums of comparison. For the first six months of 2015, using the Russell Top 200 stock index for comparison, Value Defensive stocks were down by -2.8%. Growth Dynamic stocks were up by +7.8%. Did you make the wrong choice?

You know that past performance does not guaranteed future results and investments in securities entails risk, including potential loss of principal. While diversification is important, many investors see volatility as a risk, especially downside volatility. If you opt for a conservative portfolio to try and limit downside volatility, it may not keep up when lower quality, higher-volatility-driven, or momentum markets lead the performance parade, as we have seen lately.

Low interest rates favor risk. Companies borrow money to make acquisitions or to buy back stock to elevate earnings per share. Conservative managers may sell off such a company if it is felt that high debt increases future risk. Value managers often risk “buying too soon” as a stock goes lower before it bottoms. Or they may “sell too soon” as a momentum stock continues to climb for awhile.

EIC noted, “Today’s favoring of risk is seen in corporate behavior, where companies that borrow at today’s low interest rates to make acquisitions are rewarded with stock price increases.” The report cited CVS Health, whose stock price rose on news of two major acquisitions even though the debt load of CVS increased substantially. Insurance holding giant Ace Limited announced the purchase of Chubb Corporation using debt and newly issued stock. EIC sold both stocks despite initial cheers from Wall Street.

Perhaps you opt for a bit of both value and growth, or go even further with asset class diversification, both domestic and global But in our simple example, your financial menu lists two major choices. The more stable stocks are called Value Defensive; the less stable option is Growth Dynamic. Stability is measured at the company level relative to price and earnings, leverage (debt), and return on assets. These metrics reflect sensitivity to economic and credit cycles and market volatility. The value portfolio may perform better when investors at large flee to safety. But when “animal spirits” take hold and speculation increases, less conservative portfolios may outperform. Cycles, yin and yang, come and go.

You are retired and/or otherwise conservative. What is your choice?

Lewis Walker is President of Walker Capital Management, LLC. Certain advisory services are offered through The Strategic Financial Alliance, Inc. (SFA). Lewis Walker and Mike Hostetler are registered representatives of SFA which is otherwise unaffiliated with Walker Capital Management, LLC. lewisw@theinvestmentcoach.com