Stress Test Vs. Timing

Stress Testing vs. Market Timing

I’ve gotten feedback on the Portfolio Stress Testing that I offer to my financial advising customers. Much of it is good, but some wonder if I’m being true to all of my principles. “John?” my clients tell me, “you recommend against market timing, yet your Portfolio Stress Testing approach is going to shape my portfolio to guard against certain problems that may be coming down the road. Isn’t that another way of doing market timing?”

No – and here’s the simple reason. Most of my clients, if you peel back the covers, are closet market timers. Lots of clients and potential clients of mine admit to wondering what would have happened if they got out of the market just before the crash. Others wonder what would have happened if they got into a certain investment just before its big run-up. This is a very natural thing for people to wonder – I see it a lot.

Most of my clients are hoping to beat the market with their portfolios. And how do you beat the market? It’s easy – you just need to know in advance what the market is going to do, and position your portfolio to benefit from the coming change. You see the fallacy already – nobody knows what the market is going to do in advance. But that kind of guessing is the heart of market timing. Stress testing is very different. When stress testing portfolios, we build portfolios that have a general direction to them – something that satisfies my clients’ desires to drive their investments toward a goal, while still guarding against the most likely problems that can attack their portfolios.

Inflation is a great example. A few years ago, only a few of my customers were worried about the impact of inflation on their portfolios. But what a difference a few years has made! Low interest rates, large quantities of government spending, high deficits, and other factors have spooked investors about inflation so badly that some are considering buying gold to hedge against the inflation! (Crazy, if you ask me, but that’s a subject for another article.) So is it sensible to build a stress-tested portfolio that still has good income performance, but is better safeguarded against inflation risk? Of course it is. Is that market timing? Nope – that’s smart investing.

Tags: john pollock, market timing, measure, not time, prepare, stress test