Although Investments is just one integral part of total financial planning and wealth management, it stands center stage more often than Estate Planning, Tax Planning, Risk Management and Asset Protection Planning. Unlike probate costs, income taxes, home depreciation, healthcare costs, and risk taking, portfolio values can be watched daily, even by the minute. The Age of Instant Information and nearly 9 years of uninterrupted stock market recovery against the backdrop of the 2008-2009 Great Global Recession keep investors on edge. Though we hate taxes and depreciation and rising healthcare costs, they feel both boring and out of control when, in fact, they are excellent areas for planning to minimize losses.
As we age, losses are harder to emotionally withstand even when they are only paper losses and even though we have years of life expectancy. We don’t have as many years to retrace the price curve up-even though the curve down could be short-lived and a great buying opportunity, regardless of age. When we retire, we don’t have the earned income to supplement portfolio income, and aren’t adding to the portfolio (usually). Add the current global political uncertainty discussed in Macroeconomic View and it’s a good time to discuss “losing” and “losses.”
First and foremost, investment losses and gains don’t occur until they are taken or “realized.” A paper loss isn’t a “real” loss unless we cash out of the investment while its value is down from the amount invested, “realizing the loss.” A paper gain isn’t “real” until we cash out and take or “realize the gain.” Successful portfolio management involves buying on downturns (good companies share prices on sale) and selling to take good profits (not being greedy during upturns and having money to further diversify). Unfortunately, the average individual investor is unsuccessful because they do the opposite. They buy more when stocks are performing very well, buying more at higher prices, “piling in” with everyone else reading all the happy bandwagon headlines, not wanting to miss out on a good thing. These same investors sell when the market is going down, sometimes liquidating entire portfolios at the bottom of corrections or in the middle of a bear market. This behavior was rampant during the tech bubble and bust and more recently during the housing boom that was then followed by the global credit crisis that led to the Great Recession. Literally billions were being invested at the top when we were selling in 2007 and 2008; and billions were being sold while we were buying at the bottom of the market in March 2009. It took guts and understanding the macroeconomic environment…and it paid off.
Digging deeper to understand markets and “losses,” a NORMAL MARKET CYCLE INCLUDES PULLBACKS AND CORRECTIONS. Price movements in the 0%-5% range is common statistical noise. Right now we are getting a tremendous amount of statistical noise. Beyond 5%, there are three types of market downturns which when understood will lead to better investment decisions and portfolio management. A pullback is a 5%-10% market drop; a correction is a 10%-20% drop; a bear market is a 20%+ drop.
Noise and pullbacks need to be ignored unless you are a day trader. The reason is because they are short-lived and it’s almost impossible to buy back in at anything other than higher prices than the sells. Portfolio decisions during a correction are a function of risk tolerance, income needs, capital needs, and time horizon. Long-term investors with truly diversified portfolios, especially with portfolios that exceed the capital needed for life expectancy, as well as portfolios being added to, should use corrections as opportunities to buy more of oversold, well-run companies.
One of the disappointments during the past few years has been the whipsaw nature of pullbacks and lack of time to buy more. We have lamented in the Commentary how we look forward to a long overdue correction as an opportunity to buy more of good funds and ETFs.
Clients who cannot tolerate corrections are by definition risk averse and should be in our most conservative Growth & Income model, less than 50% stock exposure. So when stocks are down 10%-20%, those portfolios should be down maybe 6%-12% depending on what’s happening with bonds. Aggressive clients by definition should be unconcerned with both corrections and bear markets. It’s the Growth clients, whose portfolios have less than 65% stocks, who generally want to have most of the up and little of the down. Even though those portfolios are positioned to avoid at least a third of a correction, a Growth portfolio by definition means most of the money is invested for the long haul (more than 5-7 years), with more than a third for the short haul (2-4 years).
We asked Kyron to conduct a totally nonscientific analysis of the portfolios we manage, choosing a typical one from each of the 3 models for the period January 26 through March 29, from the stock market price peak to the end of the quarter. The only criteria was that the client could not have added nor taken out any money during this 1st Quarter 2018 on which we are reporting. The question was, given all the volatility AND the correction that John reported in Markets and Trading, how much did our respective portfolios decline? As we (your Investment Committee) expected, here’s the performance of our managed portfolios: Aggressive Growth: -5%; Growth: -4%; Growth & Income: -3.2%; S&P 500: -8.1%.
We look forward to discussing how YOUR portfolio performed during this and other periods. Of course, cash flows in and out will have an impact on performance. For instance, if you added money to your portfolio and wanted it to be invested immediately during market highs, that portion of your portfolio would be down compared to someone with the same portfolio who withdrew the same amount at those highs. Regardless, the main lesson is that whatever the Dow 30 Industrials performance is today, whatever the S&P 500 has racked up (or down) for the day/week/quarter, whatever the NASDAQ has plummeted or skyrocketed, your portfolio is performing differently because it is being professionally managed to garner as much of the upside and as little of the downside as possible, given its objective.
Is your portfolio positioned in the right model for your risk tolerance? What is your life expectancy? What percent of your portfolio do you need in the next 5 years? Let’s discuss these and more factors in your next portfolio and planning session. Let’s also review your tax return, your estate plan, your car depreciation, and your health care costs – all areas in which you may be experiencing unnecessary losses.