The Importance of a Portfolio Stress Test

In recent years, the markets, the economy and the global political scene have evolved considerably. We’ve witnessed both remarkable volatility and remarkable resilience in these areas. The reality is that less predictability in today’s economic landscape requires more vigilant risk diversification, coupled with the ability to adapt to a fast-changing environment.1

During the financial crisis when banks began failing, the Federal Reserve and the International Monetary Fund (IMF) began instituting various stress tests to ensure against failure. A stress test is an analysis performed under unfavorable economic conditions designed to determine whether a bank has enough capital to withstand the impact of adverse developments.

Similarly, when building a retirement portfolio, it’s important to stress test your positions against the most unfavorable of market conditions. Most people remember their assets dropping in 2008, but to what extent have the positions that you owned during that period changed? We help our clients understand exactly the risk that their portfolio contains, and what would happen to their current positions if there was a repeat of the last recession.

There are two primary ways of reducing portfolio risk and surviving a portfolio stress-test. The first is to implement fixed, or guaranteed, investments into your portfolio. Only investments that can not lose money can give the most accurate results during a calamitous market. The second method is tactical management. Tactical management is a type of market timing, but it focuses more on short-term movements, particularly risk, and seeks to avoid dramatic portfolio swings.2 By combining these two strategies, we can forecast the worst of financial recessions and even depressions and still allow our portfolios to safely weather the storm. This is only done however, by proper planning and a thorough testing of your portfolio’s weaknesses.

 

 

 

 

 

 

 

 

1 Nasdaq. June 26, 2017. “Asset owners must be more innovative to fulfill investment missions.” http://www.nasdaq.com/press-release/asset-owners-must-be-more-innovative-to-fulfill-investment-missions-20170626-00612. Accessed July 8, 2017.

2 Chris Chen. Insight Financial Strategists. July 1, 2017. “Tactical asset allocation can enhance a long term strategy.” http://insightfinancialstrategists.com/asset-allocation/?utm_source=ReviveOldPost&utm_medium=social&utm_campaign=ReviveOldPost. Accessed July 8, 2017.