Other Options for Reducing Risk

We noted yesterday that alternative investments can provide the diversification needed for downside protection in case the stock and bond markets turn bearish.

Two other suggestions for reducing risk were covered by Burton Malkiel, chief investment officer of Wealthfront, in The Wall Street Journal – investing in international stocks and rebalancing your portfolio.

International Diversification

“Most investors fail to realize the benefits of broad international diversification,” Malkiel wrote. “The world is currently enjoying a synchronized expansion, but economic conditions and stock performance are not perfectly correlated across nations. Internationally diversified portfolios tend to see less volatile returns over time and better risk-adjusted performance.”

Investors typically invest all or most of their money into domestic stocks, according to Malkiel. In doing so, they are failing to invest in most of the economic activity taking place in the world.

Malkiel notes that emerging markets in particular, which have younger populations, are growing faster than the U.S. economy.

In addition, stocks in other countries have not performed quite as exuberantly as they have in the U.S. The CAPE ratio for emerging-market stocks is less than half of its equivalent valuation in the U.S. The emerging-market CAPE is even below its historical averages, in spite of superior market performance in 2017.


Another way to control risk, he wrote, is to regularly rebalance your portfolio to maintain a consistent asset allocation.

Investors who, for example, held a moderate percentage of assets in stocks have likely seen that percentage increase in recent years due to the superior performance of the stock market. By rebalancing and keeping a set percentage of holdings in a wide variety of assets, investors can automatically buy low and sell high.

Malkiel also suggests investing in REITs and preferred stock, and reducing fees by investing in index funds and exchange-traded funds.

“If rebalancing is required to constrain portfolio risk,” he wrote, “consider REITs and preferred stock. Good-quality preferred stocks yield about 5%, and many have yields that float with interest rates, so that they offer some protection if rates rise in the future. Mid-single-digit returns may seem unattractive relative to recent asset returns, but with valuations at current levels, low-single-digit returns could end up looking good.”

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