Designing Your Portfolio’s Thermostat

The stock market is volatile but you can increase your comfort level by careful management.

You may recall years ago if you set your thermostat at 70 degrees Fahrenheit you would experience three conditions within the hour.

  1. 30 minutes of comfort
  2. 15 minutes of suffocating, and
  3. 15 minutes of chilly.

The thermostat was at fault.

A thermostat is just a special kind of switch.  When set at 70 it might not turn on the heat until the temperature fell to 67 and it would not turn off until it reached 73.  The range is called overshoot and undershoot.  There was a gauge inside that you could adjust so the difference was less. 

At about 1 degree each way you barely notice the temperature change, but if it is very cold outside the furnace may turn on too often.

When you look at your portfolio, you have the same problem.  How much up and down is comfortable for you?

By diversifying, you set the over/under range.  If you want to be comfortable you must be willing to give up overshoot to avoid undershoot.

Find a person who can help you build a portfolio based on your comfort zone. But first discover what your comfort zone is.

There is a way to know.  What change keeps you from sleeping.  People get excited when the market is up more than they expect and they become frightened when it is down.  Notice when you are losing sleep.  The wisdom is – adjust your portfolio so it fits inside your range.

Unlike a thermostat, your range need not be symmetrical.  Designing for losses in any year less than 3% and giving up profits over 12% could be yours.  People can design toward that.  It will not always work exactly but life is about tendencies not certainties.

Andy Martin in his book Dollarlogic talks about how important it is to be able to predict yourself. True it is.

It is important to learn about how the various investment products and markets work, but the first task is understanding how you, and the people close to you, work.

Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

Contact: don@moneyfyi.com  705-748-5181

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