Time to Take Stock of Your Portfolio

09/10/2013 9:00 am EST

Focus: STRATEGIES

Kelley Wright

Managing Editor, Investment Quality Trends

In our view, the sole purpose of investing is to realize a return on investment. One half of that equation is the cash dividend, which is the most immediate and tangible return on investment, explains Kelley Wright of Investment Quality Trends.

In our approach, buying right means to acquire shares when they represent good value. Good value, from our perspective, is a historically repetitive area of low-price/high-yield.

Implicit in our approach is that once a position is taken in an undervalued stock, as long as the company remains fundamentally sound and produces sufficient earnings to maintain its dividend, the stock is held until it reaches overvalue, which is its historically repetitive area of high-price/low-yield.

This holds true even in the event of a major market decline, which is why we emphasize the importance of having an investment time horizon that will allow for the inevitable cyclical market contraction to dissipate then recover.

Riding out a market contraction requires a degree of discipline that most investors do not have, however.

Even with a long-term investment time horizon, and the knowledge that a stock purchased at historically undervalued levels will eventually cycle through to historically overvalued levels, it is far more emotionally comfortable to avoid a major downturn and long recovery period than it is to survive one.

In our experience, much of the discomfort of a major market contraction can be avoided by limiting stock purchases to periods when the broad market offers good value.

Two of the tools at our disposal for gauging whether the broad market offers greater risk or greater reward are the percentage of our Select Blue Chips in our Undervalued category, and the current dividend yield of the Dow Industrials. Once again, in our experience, when one or both of these measures indicate that the potential for market contraction is greater than the potential for further market expansion, perhaps the better part of valor is to avoid making new purchases and/or to reduce positions with large enough capital gains that would be emotionally uncomfortable to lose, even if they had more theoretical upside to overvalued levels.

This is not to suggest that I am recommending that you engage in market timing. What I am suggesting, is that you need to consider, not just now, but anytime your capital is exposed to risk in the stock market, whether the portfolio you own today is the portfolio you would want to own through a major market downturn until it is exhausted and the portfolio recovers.

If you are hesitant to answer or your answer is, no, you do not intend to maintain your current portfolio through a major market downturn until it is exhausted and recovers, then you probably have a greater exposure to risk than you are emotionally prepared to endure.

Although the Dow has shed some 700 points over the last week or so, I would still characterize the current broad market valuation as significantly less than attractive.

This, of course, does not mean that the market will not recover this loss, it probably will, this time. If the market does go on to make another new high, however, it will not be for organic reasons.

The markets are not acting on fundamentals, rather, the belief that the Federal Reserve will not allow the broad market to decline similarly to 2007-2009. That's a lot of faith to put into a theory without any significant historical evidence.

September and October are both historically, and statistically, the most volatile period of the year for the broad markets.

As such, it would be prudent to take stock of your portfolio and make a frank assessment as to whether this is the portfolio you are comfortable with, come what may. If not, then make adjustments. Forewarned is forearmed.

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