Tuesday, October 11, 2011

Stick to the Plan

One day it's up. Another day it's down. And it's beginning to feel a bit like Groundhog Day. 

We know that the last six months have been extremely challenging for investors. We know that your September statements and quarterly performance reports are very discouraging.  We can understand that there may have been times when you felt like throwing in the towel, given the current economic and financial environment.  But we can't let our emotional reactions to current events drive our long-term financial decisions. This is what causes average investors to fail over time; selling low (when everything seems dismal) and buying high (after we feel comfortable that everything will be okay). And it is also why we still advocate that the best way to manage money is to develop an appropriate Asset Allocation plan based on your long-term goals, time horizon, and personal risk tolerance -- and then to stick to it through thick or thin.  We know this takes patience and resolve -- and, yes, maybe even courage at times.

We are confident, however, that any long-term investment plan must still include a significant allocation to a diversified basket of equities. The challenge of being an equity investor in times like these is to remember that we aren't invested in the elusive "stock market", with its daily fluctuations and unpredictable swings, as much as we are part owners of profitable, cash-rich companies all over the world - Apple, Exxon Mobile, FedEx, Daimler,  Samsung, .....  And the shares of many of these companies are at least fairly valued, if not undervalued, in historical terms.  If you believe, as we do, that the global economies will eventually work their way out of their financial problems and this recessionary environment, then you need to be part of the recovery when it happens, even though we can't know how long that will take or how much more pain is still ahead of us.

For the vast majority of us, our Financial Plans require that our investments achieve long-term returns in excess of inflation so we can maintain our lifestyles during retirement. Investing (and remaining invested) in a broadly diversified portfolio of Domestic and International Equities, Real Assets, and Fixed Income has been a successful strategy in the past (including through the 2008-2009 financial crisis and its subsequent recovery), and we believe it will still be so in the future. That is, if you can stomach the sea sickness without jumping ship.

So what other options do we have as investors?  Aside from Asset Allocation (which forms the basis of our investment strategy), we have a few other investment choices. For starters, we can try to “time the market”; that is, to buy stocks before they go up and to sell them before they go down. Or, we can “loan” our money to banks and governments through bank accounts and government bonds. 

The first plan would be great if it worked. But the odds are against being successful at this strategy.  We do not believe that anyone can do this consistently and over long periods of time. Sure, you could get lucky in any given year, but one wrong decision can, and has, ruined many.  And being partially successful at this strategy is like spinning your wheels but getting nowhere.

The second plan is to “get out of the stock market” altogether.  This might ensure that we never lose money during any particular time period, but our long-term, inflation-adjusted returns are almost guaranteed to be terrible, given the current state of interest rates and government finances.

Yes, there many other investment options, such as gold, annuities, and hedge funds.  We’d be happy to discuss any of these with you in greater detail. But these investments also have their own risks and trade-offs that need to be taken into account. 

So, the next time you feel like throwing in the towel, try to remember how you felt in March of 2009. Remember that nobody at that time felt that it was a great time to put new money into stocks (except maybe Warren Buffet).  Instead, the majority of people were feeling shell-shocked and extremely worried that the stock market (and their retirement portfolios) would never come back in their lifetimes. In hindsight, that turned out to be a great time to invest in a diversified portfolio.  During the market crash caused by the financial crisis (9/30/08 - 2/28/09) our model Diversified Equity Portfolio went down 40%. However, since then, through September 30, 2011, the same model Diversified Equity Portfolio earned almost 75%, and the total return for the last three years from 9/30/08 - 9/30/11 has been 4.5%.* Those of us who rode out the storm were able to recover quicker than expected, and we believe the same will be true this time.

Please feel free to contact us anytime.  We don't want, or expect, you to feel as though you need to go it alone.

* May not reflect your actual portfolio performance depending on variables such as withdrawals and additions, dividend reinvestment, and timing. Model Diversified Equity Portfolio comprises 30% DFA Core Equity ll, 30% DFA Vector Equity, 15% DFA Int’l Core Equity, 15% DFA Int’l Vector Equity, and 10% DFA Emerging Markets Core Equity.  For additional information and methodology, please contact our office.