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Financial Preparedness - First Quarter, 2008

Jeff White

March Madness of a Different Kind

While sports fans enjoyed the seasonal madness of the NCAA basketball tournament, investors have been less enthusiastic about the madness that continued in their portfolios through March. However, much like the poised coach or point guard that kept his composure during an intense game, investors, too, must remember that portfolio success requires having that same confident composure. To succeed in both, one must be confident with their plan and have the discipline to execute that plan. For investors with a solid investment policy and the discipline to stick with it, large swings in the stock market present opportunities, not panic.  Having a solid investment policy is to first determine your tolerance for risk and volatility. If you weren’t sure of your tolerance for volatility before last fall, you certainly have a better feel for it after several swings in the Dow, ranging from a high of 14,200 to a low of 11,500 over the past six months. 

A confident investor understands that a traditional portfolio consists of six parts, including fixed income and five types of investments in stocks. Those investments in stocks range from conservative large companies to exotic foreign based companies, all representing different risks and returns throughout the same period. Much like the five players on a basketball court make different contributions to a winning game, your portfolio does the same. In some games, the point guard has a great game. However, you don’t notice the coach putting five point guards on the floor for the next game and sitting the other four positions on the bench. That’s because he understands that each player on the court will make a contribution at some point during the game which will result in winning the game. More importantly, the coach understands that the player most responsible for the win will be different in just about every game. Portfolios do the same. Each of the five different types of stock investments will make contributions towards a winning return, as long as you don’t take players out of the game and load up with five of the same type of player. Over the last six months, investors without a plan or the discipline to stick with their allocation across the five classes of stock investments have moved in and out of the market, chased last year’s winning asset class, even sold out of stocks completely when the market was at 11,500, and bought 10 year bonds yielding 3.2%. This is the definition of panic, not discipline.

Since the low of 11,500 in January, the market has increased by over 1,000 points. The confident investor understands that when the market goes up, they will become over weighted in stocks. But it takes a disciplined investor to pull money out of the market at that point and convert it to fixed income. At those levels, most people think that what goes up is going to continue going up. Likewise, when the market goes down, very few people have the courage to invest cash to rebalance their portfolio in a market that has experienced a significant drop. After all, there are those that believe that what goes down will probably continue to go down. 

But remember, the whole point of building a mix of different types of assets based on your goals, time horizon and risk tolerance, and then rebalancing back to that blend on a regular basis is that you can’t predict the future. You can’t predict when the market will go up or when it will go down. By the time you’re comfortable with the market again, you’re likely to have missed 90% of the return for that year and very likely to have bought at a new high, when people again believe that what goes up is going to continue going up.

So, to assure success of a winning portfolio, make sure you have a solid investment policy and force yourself to have the discipline to stick with it. In the long-term, you won’t regret the short-term panic decisions you didn’t make, nor will you be sitting on 3.2% bonds eight years from now wondering how you let short-term concerns influence long-term goals.

But more importantly, if you stray from your game plan too often and begin basing your rebalancing decisions on gut feelings about what the market may or may not do and when it might or might not do it, you don’t really have a plan anymore. You’re just playing hunches, and nobody wins playing hunches.

For those who lack the discipline to make the hard decisions, get yourself a coach, an advisor who will make them for you. You’ll thank them for having the composure to guide you through the tough markets.

If you would like more information on how InvesTrust can be your coach, please do not hesitate to contact us.

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