Timing is important.
When the old Medicine Man was asked if rain dances really work, he answered that they most certainly do but a lot depends on timing. "How are your investments doing?" may be one of the most complicated of all investment questions.
There is a stark dearth of considerations: relative to what benchmark; over what specific time period; for what risk level? Measuring the twelve months ended March, 2009 would have resulted in horribly negative returns (S&P 500 was down -39.7%, excluding dividends) using most any long strategy. Measuring the twelve months ended September, 2009 was only modestly negative (-9.4%), while returns for the year ended December, 2009 were strongly positive (+23.5%). ?
Moreover, a portfolio that fared relatively well during the downturn (ie, declined less than the overall market) may not have fared as well for the rally. In fact, a defensive portfolio would be expected to produce results inferior to the overall market in strong years such as 2009. Conversely, an aggressive portfolio would be expected to suffer much more than the overall market in declining markets while rebounding more quickly than the overall market as the markets rebound. ?
Choose your ride.
My 17 year-old son and I test drove a Ferrari recently. He is sort of a car nut. We were never considering actually purchasing the car, but we thought it would be cool to take a spin. When we saw a 2006 for sale by a local dealer, we headed right over. It was awesome; we felt like James Bond. It was low-slung, sexy, raw power. We found a straight, quiet road and prayed for no cops. Robert and I concluded that we would likely kill ourselves in that car. We would die happy but die nonetheless.
Investing for me is about the same as NOT choosing a Ferrari. Larger, safer, and more comfortable characterize my automotive and investment choices. Ferrari drivers and derivative traders are not wrong; their lifestyle is just not for me. My great friend P.J. O’Rourke would rightly point out that I’m sounding old, but he drives a 1987 Suburban and has limited room to comment. (P.J.’s latest book, Driving Like Crazy is tearfully funny, especially if you like cars.)
The choice of your investment ride will have pros and cons which will change as market conditions change. I’ve never been a wild risk-taker, and I’m becoming even less risk-tolerant as the years pass. The portfolio for me tends to keep up during strong markets and perform very well (on a relative basis) during weaker markets. Investors often forget the performance trade-offs they’ve made when conditions are dry and sunny and it would be fun to put the top down. After all, piles of snow and ice seem very distant when balmy breezes blow. However, it should be recognized that keeping up in strong markets and declining less in weak markets is a very effective way to achieve positive long-term performance in your portfolio. This is the Farr, Miller & Washington approach.
Stocks Still Make Sense.
I may advocate caution, but I hardly long for a return of the horse and buggy. It was John Maynard Keynes who said, "In the long run, we’re all dead." While the context for this statement was something altogether unrelated to investing, I think we can apply his sentiments here. The fact is that many of us don’t have the luxury to wait decades to achieve our investment ambitions. Stocks, simply put, are a necessary investment component for many of us to meet our retirement, philanthropic or inheritance goals. A well-structured bond portfolio, which provides income and capital preservation, can provide a great anchor for many portfolios. However, as we look out over the next decade, stocks appear likely to outperform bonds following a decade in which the opposite occurred. Moreover, bonds with longer maturities can be volatile and, adjusting for inflation and taxes, bonds have provided meager historical returns. These returns are likely to be even more meager as we begin the decade at near-record low interest rates. Yes, again, I know that bonds were great over the past ten years, but that was an exception not the rule. Investors are always well-advised to expect the historical norm and not the exception.
Some allocation to stocks makes sense for most people. Long-term historical returns for stocks well exceed similar returns for bonds. People seeking a higher rate of growth in order to meet long-term goals can ill afford the pony-cart pace no matter how safe it feels. A sufficient time horizon argues for stocks too. A longer time horizon allows a greater chance for long-term trends to emerge. Baby Boomers suffered significant wealth erosion. Retirement dates have been postponed, and investment plans have been revised. The larger historical returns from stocks will be necessary for many Boomers to achieve their retirement objectives.
It’s easy to feel doubtful, insecure, and even scared when you hear that something that you own is lagging or that something you don’t own is rocketing. The resulting fear can easily lead to mistakes. Here’s the advice: have a plan that has a logical and reasonable chance of achieving your investment goals. Commit to your plan and ignore the noise. The only important investment goals and achievements are your own no matter what anybody on TV says.
We’ve been through an amazingly difficult recession and stock market cycle. While the downturn may not be over, you are armed with a lot of new experience to bring to your own investment planning. I recommend a review of your goals and of your risk tolerance. As years pass, investment horizons shorten. Money that is needed sooner should be safer. If you barely survived this recent March 2009 bottom, now is the time to adjust your plan and become more defensive. I’m not advocating a rush to bonds. In fact, bonds seem expensive to me. If you need help modifying your plan, call an investment professional and ask for some help.
Ferraris are cool, but there are darn good reasons why retirees don’t usually drive them.
Michael K. Farr is President and majority owner of investment management firm Farr, Miller & Washington, LLC in Washington, D.C. Mr. Farr is a Contributor for CNBC television, and he is quoted regularly in the Wall Street Journal, Businessweek, USA Today, and many other publications. He has been in the investment business for over twenty years.