Investing Again After the 'Shock and Awe' of Losses
In the last three weeks, I've met with three potential new clients who had one very striking thing in common. They each had over $1,000,000 — individually representing a third to half of their entire net worth — in cash! They each have maintained some equity exposure in their portfolios, but the "shock and awe" of losses sustained in 2008 still looms large in their psyche.
So, was it just a coincidence that three people sitting on a pile of cash, each a different age and professional background, would be seeking out new professional advice at roughly the same time? Or, is their situation typical of investors regardless of age, background or size of portfolio?
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Like many investors worldwide, their personal risk tolerance was recalibrated in 2008, resulting in a fear- induced stockpiling of cash. They each expressed the same sentiment: for a while having so much cash helped me sleep at night, but now I am losing sleep over the fact that it earns me nothing while inflation erodes its buying power daily.
They face the trader's perpetual dilemma of knowing when it's time to come out of the market and when it's time to go back in. As they have learned choosing when to return is the harder call, which is why timing the market isn't a strategy for the long-term investor.
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I do not believe it was coincidence that they, and many like them, are seeking professional advice; it is the numbers. A few weeks ago, on Feb. 1, the Dow Jones Industrial Average, after more than a five-year slog, rebounded back above 14,000, approaching its all-time high of 14,166. The realization that too much cash can lock-in losses and cannot "rebound" has many asking if it is finally time to pick up where they left off five years ago, or have they missed the "run," questioning if the market is overheated and setting up for a new fall.
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Fear needs to be set aside.
While it is certainly reasonable to expect a modest market correction over the short run, as I pointed out recently, for the long-term investor there are several reasons to pull excess cash out of the bunker and be optimistic about the future. For a cue take a look at what companies are beginning to do with their cash. Corporations, which also have been sitting on stockpiles of cash, have begun to demonstrate that their appetite for risk is coming back.
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Some have dubbed February "Megadeal Month."
Here are just two of February's megadeals that represent the kind of signposts to note. Michael Dell announced he was leading an investor group in a leveraged buyout of Dell for $24.4 billion — the biggest leverage buyout since the financial crisis began in 2007. Warren Buffett's Berkshire Hathaway teamed with U.S.-Brazilian private-equity group 3G Capital to buy H.J. Heinz for $28 billion, and Buffet says his "elephant gun" is loaded for another big acquisition. The take away: both Michael Dell and Warren Buffet believe it is time to start putting their stockpile of cash to work.
Other positive developments include a housing rebound, and the sense that Europe is beginning to solve its problems.
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If you read these signs that the long-term outlook is indeed turning favorable and risk is diminishing, the only thing that might hold you back is fear of volatility.
It's important to remember that while risk and volatility are related, they're not twins.
Risk should be considered as the danger of not hitting a goal (a long-term inflation beating annualized positive return on you invested capital) while volatility is a measure of how bumpy the road might be on the way to achieving that goal.
There will certainly be many ups and downs ahead, but if you're still sitting with a lot of cash, it's time to reassess your position. Depending on your situation, it might not be the prudent choice. Cash is earning virtually nothing, and though inflation is slight, it's chipping away at what you've got. Nowadays, the fixed income market is starting to look risky, as interest rates continue to scrape the bottom and bond prices remain at near-historic highs.
For the individual investor, getting back in shouldn't mean picking five stocks and placing your bets on them. It means — as always — putting together a well-diversified portfolio, for example with a mix of bonds, large-cap and small-cap equities, as well as international investments.
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Your personal time frame determines how you should be invested. If you're investing for the future, your decision-making should be based on where things are headed rather than where they have been.
If you are one of the many people maintaining an uncomfortably large cash position, I offer this thought: when you burn your finger while cooking, it's sensible to be wary of the stove. But it makes no sense to stay out of the kitchen entirely.
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Kenneth A. Kamen is a managing director of The Mercadien Group and president of Mercadien Asset Management and Mercadien Securities, as well as the author of the highly acclaimed book from Bloomberg Press, "Reclaim Your Nest Egg: Take Control of your Financial Future."