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This is where advisors can add value by helping their clients through behavioral coaching. Regardless of their expertise or level of sophistication, investors often need help navigating through complex market cycles or holding onto investments that have underperformed for any length of time. Through behavioral coaching, advisors can better suggest the right asset manager or actively managed fund for their clients.
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That being said, there are at least four common threads that apply to portfolio construction and these will be relevant for the majority of investors.
This framework is likely to work much better for investors who aren’t risk-averse. Investors who don’t fall into this camp may be better off with a simple indexing strategy, which has been shown to provide steady returns over the long haul.
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As Vanguard notes, not being fully diversified in today’s market carries significant risks. According to the widely cited study by Gary Brinson, et al. in 1986, asset allocation accounts for 90% of an investment’s variability. Since asset allocation largely determines how a portfolio performs, diversification across asset classes is critical to long-term success.
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This means constructing a portfolio that can cope with various market trends, while also taking into account the client’s investment goals, situation, and underlying risk tolerances. By working with an advisor, investors can employ active strategies to navigate through choppy market conditions. At the same time, there are several methods an advisor can employ to reduce portfolio volatility. These include asset diversification, reducing downside risks by evaluating how much a fund declines relative to its benchmark during bearish cycles and re-balancing when necessary to ensure original asset allocation is maintained. While this may come at the expense of higher returns, it addresses the concerns of investors who are overly worried about volatility.
Currency-hedging decisions should take into consideration factors such as investment time horizon, asset mix, and risk preference, among others. In other words, the hedging strategy must follow the portfolio’s strategic asset allocation. For example, fixed income portfolios should be hedged to local currency. Without this, the volatility of currencies in international bonds can offset the diversification benefits. On the other hand, when investing in foreign equities, adopting a systemic approach to currency hedging is necessary. This may include hedging with currency futures and, over longer-term horizons, passive hedging strategies that rely on currency trends, valuations and global interest-rate differentials.
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