Emotions drive most discussions about money and finances – a fact that is maddening if you are the sort of person who likes to rely on numbers and analysis. One way to defend against the push-pull between fear and greed is to develop a strategy that you can consistently implement—I boil down my strategy to the following two words: lose less.
You have to use a strategy that fits your personality or else it just won’t work over the long term. I learned early on that I am not a great loser—it’s not that I blame anyone else, but I just don’t like the feeling. In fact, in the emotion-o-meter of life, the needle flies to the danger zone when I lose, while winning barely nudges it past the mid-point. Knowing this fact helped me to determine that as an investor, I would be better off limiting losses on the downside, rather than attempting to beat the index on the upside. I am also a fan of statistics and since it was rather difficult to outperform the index in the abstract, I figured that it might be worth trying to do so when everyone else is in high panic mode.
There is only one problem with my system: it runs counter to the normal cycle of fear and greed. I discovered this first-hand from 1999-2003. In 1999 and 2003, when stocks were soaring, I would remind investors that it’s not prudent to try to assume the risk necessary to beat the index, while in the three-year bear market when we were actually beating the index (often by double -digits), people would say, “I know that the S&P 500 is down 25% and my portfolio is only down 4%, but we are still down!” (Cue the sad music!)
Only in retrospect can I truly appreciate that losing less may not be a sexy strategy in the moment, but over the long term, it provides many more restful nights and results that can usually help people reach their goals with less volatility. That fact was driven home when I read some amazing statistics this week in the Wall Street Journal. (Stocks Tarnished By 'Lost Decade' By E.S. Browning March 26, 2008) “The stock market is trading right where it was nine years ago. Stocks, long touted as the best investment for the long term, have been one of the worst investments over the nine-year period, trounced even by lowly Treasury bonds.”
Of course if you were a diversified investor with a mix of stocks, bonds, cash and commodities, you probably did far better than these numbers, but during the big up years like 1999 and 2003, you had to accept lower returns. If you are like me, you may find that losing less may not be especially sexy, but it sure can be rewarding.
Friday, March 28, 2008
Thursday, March 27, 2008
Bail out Blues
Note to self: do not turn on acerbic talk radio program after leaving a relaxing acupuncture appointment. I wish I knew that before I got into my car last night and tuned into hear a local host ask her listeners: “How do you feel about your tax dollars being used to bail out fat cats on Wall Street?” Almost immediately, I tensed up and felt my blood boil.
I know that talk radio is a bastion for vitriol, but I am getting sick and tired of hearing the Bear Stearns story being framed as taxpayer-financed bail out, as if we had nothing to lose by allowing Bear Stearns to fail. What seems ridiculous is that many of the hosts who are throwing out these types of remarks have absolutely no idea what they are talking about. (I looked up the biography of the host in question and found that her primary career has been as journalist, covering “murder, mayhem and the Mafia for nearly ten years.” While she may have been a capable writer about these topics, it seems almost irresponsible for her to spew opinions without fully understanding the layers of this financial crisis.)
Like most news stories, this one is nuanced and deep, two concepts that normally evade sharp-tongued folks who flood the airwaves. Yes, on the surface you could say that the Federal Reserve helped to save Bear Stearns by assuming $29 billion of hard-to-price securities (in essence, putting billions of dollars of taxpayer money at risk) in order to facilitate the purchase of Bear by J.P. Morgan. You could also argue that due to the interconnected global financial markets, the failure of Bear Stearns would have likely had far-reaching ramifications, some of which the radio host and her listeners may not have liked too much.
One outcome of the democratization of investing is that “the fat cats of Wall Street” now include the vast majority of US employees. Most people own financial assets, either directly or through retirement/pension plans. So let me ask you fat cats how you would have felt if on March 17th you woke to news not of a Bear Stearns bailout, but of its bankruptcy? My guess is that US stocks would have plunged on the news—given the mood on the street the previous week, a Bear bankruptcy could have driven down the Dow Jones Industrial Average by 10%--about 1,000 points.
Some hard core free-market fundamentalists believe that this type of purge would have been the quickest way to get to true “price discovery”. Of course that kind of purge could also have led to a domino effect infecting other financial institutions and miring the US economy into a deep and painful recession. That does not seem like an appealing alternative, does it?
One point that should be raised is that the democratization of investing may necessitate expanded Federal oversight. Once the Fed began to lend directly to investment banks instead of to their normal customers (commercial banks), the central bank made that outcome a fait accompli. I am sure that the radio host will frame this as another example of “government getting into your business,” but perhaps you will see through that kind of rhetoric to understand that there is always more to the story than the simple sound bite.
I know that talk radio is a bastion for vitriol, but I am getting sick and tired of hearing the Bear Stearns story being framed as taxpayer-financed bail out, as if we had nothing to lose by allowing Bear Stearns to fail. What seems ridiculous is that many of the hosts who are throwing out these types of remarks have absolutely no idea what they are talking about. (I looked up the biography of the host in question and found that her primary career has been as journalist, covering “murder, mayhem and the Mafia for nearly ten years.” While she may have been a capable writer about these topics, it seems almost irresponsible for her to spew opinions without fully understanding the layers of this financial crisis.)
Like most news stories, this one is nuanced and deep, two concepts that normally evade sharp-tongued folks who flood the airwaves. Yes, on the surface you could say that the Federal Reserve helped to save Bear Stearns by assuming $29 billion of hard-to-price securities (in essence, putting billions of dollars of taxpayer money at risk) in order to facilitate the purchase of Bear by J.P. Morgan. You could also argue that due to the interconnected global financial markets, the failure of Bear Stearns would have likely had far-reaching ramifications, some of which the radio host and her listeners may not have liked too much.
One outcome of the democratization of investing is that “the fat cats of Wall Street” now include the vast majority of US employees. Most people own financial assets, either directly or through retirement/pension plans. So let me ask you fat cats how you would have felt if on March 17th you woke to news not of a Bear Stearns bailout, but of its bankruptcy? My guess is that US stocks would have plunged on the news—given the mood on the street the previous week, a Bear bankruptcy could have driven down the Dow Jones Industrial Average by 10%--about 1,000 points.
Some hard core free-market fundamentalists believe that this type of purge would have been the quickest way to get to true “price discovery”. Of course that kind of purge could also have led to a domino effect infecting other financial institutions and miring the US economy into a deep and painful recession. That does not seem like an appealing alternative, does it?
One point that should be raised is that the democratization of investing may necessitate expanded Federal oversight. Once the Fed began to lend directly to investment banks instead of to their normal customers (commercial banks), the central bank made that outcome a fait accompli. I am sure that the radio host will frame this as another example of “government getting into your business,” but perhaps you will see through that kind of rhetoric to understand that there is always more to the story than the simple sound bite.
Wednesday, March 26, 2008
Panic-Proof your Portfolio – Part 2
Yesterday we started to “Panic-Proof” your portfolio so that you can better weather the stormy investment landscape. To reiterate: the most important thing is to remain calm and not to panic. One way to absorb the barrage of bad news is to rely on your game plan (assuming you have one!) to help navigate.
But here is the dirty secret of the planning process: you can’t create a plan and walk away! We have learned time and time again that if you are going to manage your money, you need to actually do something. A good start is staying abreast of trends in the economy, reevaluating holdings in portfolios on a frequent basis and investing with an unbiased eye. One five start suggestion here: never execute a trade intra-day that you have not been considering previously. If you still think the idea is a good one after a good night’s sleep and some thoughtful analysis, then go ahead and do it—one day will not make or break the trade.
The particular assets included in your portfolio should shift depending on where we are in the economic cycle. The ability to both buy and sell is imperative, especially during volatile times. Keep your strategy active and monitor your portfolio frequently, making changes as economic and market conditions indicate. Of course attempting to time the market can be a disaster, but careful ongoing reviews of your asset allocation, level of diversification and the strength of your individual holdings can enable you to respond both to changing economic conditions and to the continued appropriateness of any particular asset within your portfolio.
If you had truly believed that the US economy was headed into a recession last year, then it would have been smart to reduce your overall risk exposure. The easiest way to do that is by beefing up your cash position and steering clear of credit risk. That would have put you out of harm’s way when the high-yield and mortgage-backed bond markets collapsed. Of course the amount by which you reduce risk depends on your specific asset allocation plan.
But now that we are in the midst of a slowdown, should you peel off risk? The answer depends on your specific situation. For some, the time may have passed to make significant changes. In fact, now may be a good time to start thinking ahead and considering what your portfolio should look like when the economy recovers. After all, recessions/slowdowns are time limited and yes, it will get better. Your job is to maintain a clear mind as you survey the investment landscape before you.
But here is the dirty secret of the planning process: you can’t create a plan and walk away! We have learned time and time again that if you are going to manage your money, you need to actually do something. A good start is staying abreast of trends in the economy, reevaluating holdings in portfolios on a frequent basis and investing with an unbiased eye. One five start suggestion here: never execute a trade intra-day that you have not been considering previously. If you still think the idea is a good one after a good night’s sleep and some thoughtful analysis, then go ahead and do it—one day will not make or break the trade.
The particular assets included in your portfolio should shift depending on where we are in the economic cycle. The ability to both buy and sell is imperative, especially during volatile times. Keep your strategy active and monitor your portfolio frequently, making changes as economic and market conditions indicate. Of course attempting to time the market can be a disaster, but careful ongoing reviews of your asset allocation, level of diversification and the strength of your individual holdings can enable you to respond both to changing economic conditions and to the continued appropriateness of any particular asset within your portfolio.
If you had truly believed that the US economy was headed into a recession last year, then it would have been smart to reduce your overall risk exposure. The easiest way to do that is by beefing up your cash position and steering clear of credit risk. That would have put you out of harm’s way when the high-yield and mortgage-backed bond markets collapsed. Of course the amount by which you reduce risk depends on your specific asset allocation plan.
But now that we are in the midst of a slowdown, should you peel off risk? The answer depends on your specific situation. For some, the time may have passed to make significant changes. In fact, now may be a good time to start thinking ahead and considering what your portfolio should look like when the economy recovers. After all, recessions/slowdowns are time limited and yes, it will get better. Your job is to maintain a clear mind as you survey the investment landscape before you.
Tuesday, March 25, 2008
Panic-Proof your Portfolio – Part 1
Last week the US stock market continued to gyrate. The catalysts came in the form of the usual suspects: housing; credit; financial companies collapsing; and overall angst over the direction of everything. It’s hard to hear this, but these are the times that can define your long term performance as an investor. It’s time to “Panic-Proof” your portfolio!
First of all, remember that if you are an investor of any kind, you have signed on for some tough times. Panic-proofing does not mean avoiding all losses, but it does mean taking specific actions to lessen the chance of loss. The most important thing is to remain calm and not to panic. As I have said many times, average investors do not underperform the indexes because the pros are better stock-pickers. The biggest problem that investors face is that they purchase and sell at precisely the wrong time, usually as a result of reacting to either fear or greed.
I have hauled out the results of the Dalbar survey “Quantitative Analysis of Investor Behavior” in previous articles to illustrate this point: from 1986-2005, the S&P 500 index returned 11.9%, while investors returned 3.9%. The reason is simple: many can be led astray by their emotions. You have probably been there yourself: when you see asset prices drop, you are tempted to sell, while when you see them rising, you feel confident and pile in. This is the clearest example of how average investors consistently sell low and buy high.
To prevent yourself from falling into the emotional “sell low and buy high” trap that is often exacerbated at the peaks and valleys of the economic cycle, I am going to repeat something that I know that I have said many times: you need a plan that incorporates your risk tolerance, including your time horizon for needing to access your money; your feelings about volatility (the ups and downs of the market); and your willingness to accept losses. Only after your goals and risk tolerance have been properly addressed can you successfully manage your money with a well-diversified portfolio.
Once you have the plan, you MUST periodically rebalance your accounts. Again, diversification does not shield you from losses, but it can mitigate the extreme movements of the market (both up and down). A well-diversified investment portfolio is better able to withstand whatever blows the economy delivers and can cushion you against unexpected market risks you can't control. Tomorrow we will talk about rotation decisions that you may want to consider as the economy bounces around the lows.
First of all, remember that if you are an investor of any kind, you have signed on for some tough times. Panic-proofing does not mean avoiding all losses, but it does mean taking specific actions to lessen the chance of loss. The most important thing is to remain calm and not to panic. As I have said many times, average investors do not underperform the indexes because the pros are better stock-pickers. The biggest problem that investors face is that they purchase and sell at precisely the wrong time, usually as a result of reacting to either fear or greed.
I have hauled out the results of the Dalbar survey “Quantitative Analysis of Investor Behavior” in previous articles to illustrate this point: from 1986-2005, the S&P 500 index returned 11.9%, while investors returned 3.9%. The reason is simple: many can be led astray by their emotions. You have probably been there yourself: when you see asset prices drop, you are tempted to sell, while when you see them rising, you feel confident and pile in. This is the clearest example of how average investors consistently sell low and buy high.
To prevent yourself from falling into the emotional “sell low and buy high” trap that is often exacerbated at the peaks and valleys of the economic cycle, I am going to repeat something that I know that I have said many times: you need a plan that incorporates your risk tolerance, including your time horizon for needing to access your money; your feelings about volatility (the ups and downs of the market); and your willingness to accept losses. Only after your goals and risk tolerance have been properly addressed can you successfully manage your money with a well-diversified portfolio.
Once you have the plan, you MUST periodically rebalance your accounts. Again, diversification does not shield you from losses, but it can mitigate the extreme movements of the market (both up and down). A well-diversified investment portfolio is better able to withstand whatever blows the economy delivers and can cushion you against unexpected market risks you can't control. Tomorrow we will talk about rotation decisions that you may want to consider as the economy bounces around the lows.
Monday, March 24, 2008
All that Glitters is not Gold!
When I see a front-page article about a very risky asset class appear on the front page of the nation’s mainstream newspapers, I think to myself, “this can not be good.” So it is with commodities, the asset class where I cut my teeth as a young trader over twenty years ago.
It’s not surprising that this would happen. Investors are frustrated on two fronts: many stocks are mired at low levels as a result of the US housing recession and credit crunch and interest rates are dropping like a stone because of Fed actions and fear, making the renewal of CDs and purchase of safe US government bonds seem like a sucker bet. What’s an impatient, performance-driven investor to do? Look for what HAS done well, in other words, many find themselves in the terrible circle of buying past performers. Over the past year or so, the stand-out asset class has been commodities.
Oddly enough, many started to see hard assets as “safe” – a perverse interpretation of how these markets work. According to the New York Times’ Diana Henriques, “The booming commodities market has become increasingly attractive to investors, with hard assets like oil and gold perhaps offering a safe hedge against inflation, as well as the double-digit gains that have fast been disappearing from the markets for stocks, bonds and real estate.” (NYT: 3/20/2008)
While commodities have been seen as a hedge against inflation, it is not clear whether the type of inflation we are experiencing now—the demand push, rather than the choking off of supply, will continue. In fact, historically, commodities have weakened when the globe slows, and given that the US accounts for a good chunk of the globe, many have expected that inflation will ebb as the US economy cools down.
It appears that the recent run-up in commodities has been catalyzed by four factors: a sagging US dollar; falling US interest rates; increased demand from the emerging markets; and speculative mania. Of the four, speculation, not a fundamental economic underpinning, has been the driving force of the last 5-10% run-up in these markets, as investors tried to flee poor returns and high risks in other parts of the capital markets and chased return. When those same investors took the trade off, the result is a plunge in price like we saw on Wednesday and Thursday.
Most importantly, to hear anyone apply the word “safe” to commodities is crazy: commodities are among the most volatile asset classes and while they can certainly move up quickly, they can plunge just as fast. Commodity neophytes learned that lesson last week: the most active April contract in gold fell approximately 12% from Monday to Thursday. This is not to say that commodities are dead. In fact, I believe that we are in the midst of a long-term bull market. But it is always important to understand how even in bull markets, assets can get overheated before resuming their upward ascent.
It’s not surprising that this would happen. Investors are frustrated on two fronts: many stocks are mired at low levels as a result of the US housing recession and credit crunch and interest rates are dropping like a stone because of Fed actions and fear, making the renewal of CDs and purchase of safe US government bonds seem like a sucker bet. What’s an impatient, performance-driven investor to do? Look for what HAS done well, in other words, many find themselves in the terrible circle of buying past performers. Over the past year or so, the stand-out asset class has been commodities.
Oddly enough, many started to see hard assets as “safe” – a perverse interpretation of how these markets work. According to the New York Times’ Diana Henriques, “The booming commodities market has become increasingly attractive to investors, with hard assets like oil and gold perhaps offering a safe hedge against inflation, as well as the double-digit gains that have fast been disappearing from the markets for stocks, bonds and real estate.” (NYT: 3/20/2008)
While commodities have been seen as a hedge against inflation, it is not clear whether the type of inflation we are experiencing now—the demand push, rather than the choking off of supply, will continue. In fact, historically, commodities have weakened when the globe slows, and given that the US accounts for a good chunk of the globe, many have expected that inflation will ebb as the US economy cools down.
It appears that the recent run-up in commodities has been catalyzed by four factors: a sagging US dollar; falling US interest rates; increased demand from the emerging markets; and speculative mania. Of the four, speculation, not a fundamental economic underpinning, has been the driving force of the last 5-10% run-up in these markets, as investors tried to flee poor returns and high risks in other parts of the capital markets and chased return. When those same investors took the trade off, the result is a plunge in price like we saw on Wednesday and Thursday.
Most importantly, to hear anyone apply the word “safe” to commodities is crazy: commodities are among the most volatile asset classes and while they can certainly move up quickly, they can plunge just as fast. Commodity neophytes learned that lesson last week: the most active April contract in gold fell approximately 12% from Monday to Thursday. This is not to say that commodities are dead. In fact, I believe that we are in the midst of a long-term bull market. But it is always important to understand how even in bull markets, assets can get overheated before resuming their upward ascent.
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