Why ?troubled? markets shouldn?t affect your investment strategy.
by Reese Harper, President, CFP?
November 21, 2012
Many of our clients have asked how the ?fiscal cliff? and presidential elections will impact their portfolios. Let?s start by defining the ?cliff? and then we?ll review a few big mistakes investors make during volatile markets. In short, the ?cliff? refers to a combination of expiring tax cuts and across-the-board government spending cuts scheduled to become effective Dec. 31, 2012. Many people fear these taxes and cuts will push our fragile economy over the ?cliff?. As you review the alarming headlines, please remember journalists can be heavy on emotion and light on facts. While the problems we face are very real, the media doesn?t always offer objective, tempered viewpoints when competing for your attention. Post election, I?m personally optimistic that a compromise will be reached and that Congress will rise to the occasion and take positive steps towards putting our fiscal house in order. But when planning for retirement, we must take a broader view than what may or may not occur over the next 40+ days.
1. You?re playing the long game.
We invest our savings in companies and governments around the globe. We diversify into many different countries and industries; as the global market changes, we adjust our investments to reflect the changes the world is experiencing. This allows us to reduce risk, harvest returns, and stay current with rapidly advancing economies. Nothing has occurred that changes our investment philosophy. By holding a substantial emergency fund, saving plenty of money, and measuring our time horizon, we are able to be patient, capturing returns from the equity (stock) market at precisely the time when other investors are moving to cash, and paying a premium for safety.? Successful investors don?t react to bad news, they execute a strategy, and follow through during difficult times.
2. Information is reflected in prices.
Making changes to your portfolio after receiving publicly available information has not proven to be a successful investment strategy. Widely accessible information is quickly priced into the value of our portfolios. The pending fiscal cliff and debt crisis has been rumbling down the track for years. Since this information is widely known, we can conclude that these concerns?a dysfunctional congress, and looming fiscal cliff?are already priced into our current portfolios.
3. Treat your retirement plan like your mortgage.
We pay off our homes using a formal plan, but we typically plan for retirement with informal parameters. When paying off our home we use a precise schedule and allocate exact dollars for principle, interest, property taxes, and insurance. When planning for retirement investors should establish a monthly plan as regimented as their mortgage. Don?t miss any retirement ?payments? or you will incur penalties and increased interest, delaying your financial independence.
4. Sharp market changes are?impossible to predict.
Trying to predict when to enter and exit the market is extremely difficult. Today investors worry about the potential downside of owning equities, the risk of loss. But what of tomorrow?s fear? What about inflation, rising interest rates, and increasing health care expenses? Remember, the lower prices travel, the greater the increase in expected returns. The downward journey is not very fun, but when negative returns appear it is doubly important to remain invested since the inflection point cannot be identified in advance. In March, 2009, it was nearly inconceivable that equity prices were on the verge of one of the strongest advances in history, yet it happened. Many investors made the tactical decision to avoid losses by exiting the market, yet they missed one of the quickest and sharpest rebounds ever experienced in stocks.? Investors who purchased stocks during this period cashed in on the best Black Friday sale in decades. That particular advance, and the subsequent years? advances, carried most portfolios to levels greater than before the meltdown began. Through prudent financial planning, our clients continued to build up emergency reserves, and purchase stocks at historically low levels.
5. Timing the market is highly speculative.?
Deciding when to leave the market is hard, but it?s doubly hard to decide when to get back in. While it may seem obvious that equity prices are destined to decline over the near term, it is impossible to know the extent and duration of that decline or whether it will even occur the way it has been portrayed by the financial press. Anxious investors who wish to avoid losses are simply trading one set of anxieties for another. Experience suggests that investors who exit in similar situations rarely, if ever, re-enter the equity markets. Those who do gather the courage to ?get back in? will be faced with the new fear that every succeeding sell-off, no matter how short, might be the beginning of another significant downturn. This cycle of entering and exiting the market is one of the reasons why the average investor?s return is so poor during a lifetime. Owning equities carries the risk of loss, which is why knowing the appropriate volatility for your portfolio is so important. Risk is equal to reward.
6. Inflation.?
A well-designed financial plan will allow the interest and income from investments to support living expenses of the retiree. The goal of every investor is to outlive their retirement assets. We have often pointed out, one of the most effective means to accomplish this goal is to maintain at least some exposure to stocks. While returns on high-quality, fixed-income instruments and cash are usually stable, they are currently at real levels (adjusted for inflation) of less than zero. It is important to remember that inflation ticks away each and every day, increasing the cost of everything we need to live. Avoiding the ?risk? of equities is also avoiding the reward and this is a recipe for problems. Fixed retirement income + rising costs = not enough income. More clearly stated, a failed retirement plan.
7 Stay the course.?
Staying the course in a decreasing market is hard, especially if you?re convinced you ?see it coming?. We have already endured what may be the most difficult period for equity markets in many of our lives (2008-2009). A functioning, global market doesn?t ever fall to zero. At some point prices are low enough to spur demand. As prices decline, expected returns increase. Selling out or significantly reducing equity exposure during this time is not a viable investment strategy and this presents the distinct possibility of being left behind when the recovery occurs.
Investors? portfolios should be constructed to balance the need for return with the ability to handle volatility. We work with our clients to build a strong, multi-year emergency fund which allows them to maintain exposure to stocks during the more volatile times.
Start early, save as much as you can, and don?t get distracted by the noise along the way.
Copyright ? 2012 by Aquire Advisors.
This article is part of an ongoing initiative to educate our clients and to help them meet their investing goals.
Source: http://aquireadvisors.com/trading-for-armageddon/
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