What’s in your side pocket?

I’m pretty sure you’re thinking about the pockets in your pants or jacket. If you’re a billiards enthusiast, you might be having visions of the pockets along the side rails of a pool table — and some of the nice shots that you’ve made while playing that great game. Well, I’m talking about the strategy of segregating assets in your portfolio to minimize the risk of permanent loss of capital.

Because market volatility has begun to normalize — as evidenced by the S&P 500 moving 1 percent or more — it’s critical to revisit the timetested strategy of using shortterm assets to fund your shortterm liabilities and longterm assets to fund your longterm liabilities.

Investors have had a tailwind following the Great Recession of 2008. Since then, the S&P 500 has returned over 14 percent annualized (with dividends reinvested) with the Barclays Aggregate Bond Index trailing at 3.64 percent annualized. These are well

above longterm average rates of return for stocks and they’ve come with lower than normal volatility. 2017 is the poster child for this time period with a 21 percent return for the S&P 500 with only 8 days closing at levels more than 1 percent from the previous day’s close. To put that in perspective, the S&P 500’s average rate of return since 1969 is 10.06 percent. There’s no question — after the horrors of 2008, stock investors that stayed with it have had it very good.

So — what to do? If you don’t recall, we received the equivalent of coal in our stockings from our friend Mr. Market during last year’s Christmas season. That market correction was

nearly 20 percent — and ended on Christmas Eve. Please remember that market corrections should be considered part of the normal course of investing. I was on a panel recently in Boston speaking about risk with the chief risk officer of an asset management company. When he was asked about addressing the risk of a portfolio decreasing in value, he said, “First you need to think of risk as your partner — because she is never going away.”

Many of us have heard the old axiom in economics — there is no such thing as a free lunch. So, what’s the cost of not having very liquid, high quality, shortterm assets in your portfolio? It’s the risk some call “Feeding the Bear” — the risk of selling longterm assets at depressed prices to pay for an expense. Doing this during a bear market may result in permanent loss of capital. These types of expenses can be planned or not — regardless, it’s a risky proposition when you’re using volatile assets as a source of funds. This unpleasant experience is easily avoidable by having a minimum of six months of normal expenses in cashlike investments. Now — what’s the cost of having these types of investments in your portfolio? It’s something economists call opportunity cost — or the opportunity to make a higher rate of return.

It’s always a pleasant surprise when we find cash in our pants or coat pocket — isn’t it? Imagine how you’ll feel when you need to go into your own side pocket to take care of personal business without disrupting your longterm financial goals?