by Jonathan Clark

History has taught us that events such as the Tech Bubble, the 9/11 attacks, 2008s Market Crash, and the most recent Flash Crash can have devastating effects on investors. Nassim Nicholas Taleb, a noted finance professor coined these events, Black Swans. These Black Swan events have caused retirees 401(k) accounts to be tragically referred to as ‘201(k) accounts’! Traditional asset allocation strategies using stocks, bonds, and mutual funds to limit risk through diversification have mostly failed to protect the investor during Black Swan events. Preparing for the next event could mean the difference between a comfortable retirement and not being able to sleep at night! There are a variety of strategies you and your advisor can use to try to minimize the potential for losses in a Black Swan occurrence.

Since 2008 many have flocked to money markets, savings accounts, fixed CDs, and cash accounts. This approach can silently impact your wealth as much as the Black Swan over time because those dollars start to have less buying power due to inflation. Although inflation is present, it is critical to have a percentage of your wealth in these types of accounts for liquidity. This percentage should be determined by your overall cash flow and comfort level. The last thing you want is to be FORCED to sell mutual funds or stocks when they are low because of a need for cash!

Being prepared for the next Black Swan does not require you to avoid traditional asset allocation strategies, but it does challenge you to find alternative investments that can work in conjunction with traditional strategies. This will potentially give your portfolio balance in many market environments. A couple of alternative investments could include but are not limited to Market Linked CDs, Fixed Indexed Annuities, and market neutral investments that seek to profit in both increasing and falling markets through the use of options.

There are pros and cons to each of these strategies. Market Linked CDs and Fixed Indexed Annuities require a time commitment, generally between 5 to 10 years in exchange for the safety they provide. These accounts tend to grow more slowly than your traditional asset allocation during bull markets, but they protect your principal during unforeseen historical events. It is important to consider the financial strength of the brokerage or company when choosing a custodian for your money. Market neutral investments try to hedge investments they hold in their portfolios. Portfolio managers hedge their investment purchase using options as a type of insurance if the market were to decrease.

Whatever your approach to investing moving forward, it is becoming clear that using only traditional asset allocation strategies potentially exposes your retirement to Black Swan events. Including alternative investment strategies can help limit your overall exposure and provide potentially higher returns than money market or cash accounts. When using a professional to help determine which investments to use, it is helpful to know which licenses they hold and how they are compensated for their work. This will help you understand the potential biases that maybe affecting their recommendations.

Jonathan is part owner of Clark Financial Services and is an Investment Advisor Representative with Investment Advisory Services offered through Brookstone Capital Management LLC, an SEC Registered Investment Advisor.

Volume 8, Issue 5, Posted 9:48 PM, 03.07.2012