So far in February we have a 6.7% decline in the S&P500. We are near the November 2008 low and down nearly 50% from the peak in October 2007. Our new President’s stimulus package, along with mortgage assistance to hopefully stabilize the housing market, and a credible promise to stabilize the banking system has not produced any improvement in market psychology--YET. Mr. Market (see last Weblog) is horribly depressed as he hears the two factions in Washington debating the merits of the process—the un-fairness of it all---and the long term consequences. Many that hoped for a big rally when the stimulus program was passed are now disappointed and disheartened. When will this downward momentum stop? (Remember, Mr. Market does not have any idea of what your investments are really worth!)
You have already experienced the reality that the value of your investments will decline and that you will suffer unrealized losses. A Down-a-lot market surprise has happened. This occurrence is real and recent. There is a danger that you may make the error of Recency Bias, defined as the tendency to be excessively affected by the pattern of recent data. This is the first of what I like to call the “hidden risks of investing”.
The second risk is inflation. It has been a long time since we have experienced double digit inflation, but with huge government deficits and a lot of monetary stimulus, the risk is real. Cash and bonds perform poorly in an inflationary environment.
Another important risk to understand is defined as Benchmark Risk. Of all risks, this is probably the least understood by most investors. There are many fancy technical definitions and measurements used by professional money managers and academics, but the basic principle is reasonably easy to understand. The first step in constructing an investment portfolio is the selection of the correct Asset Allocation and the corresponding Benchmark for you. This can be a complicated process, but for the sake of discussion, let’s assume that one possible Benchmark is the well known general domestic all-equity market index known as the S&P500.
A Benchmark is the standard to which we compare results. Benchmark Risk is created when we deviate from the basic make up and character of that standard. For example, if our Benchmark is the all-equity S&P500 and we decide that our portfolio will move to all bonds and cash. In this case, we have created a risk that the performance of our portfolio may not be comparable to the Benchmark--and that we will not reach the intended long term goal. Here’s a quote from Ken Fisher in his excellent book that I recommend: The Only Three Questions That Count (John Wiley & Sons, Inc.- 2007) “The only time I am ever comfortable beating the benchmark by a lot—taking on massive amounts of benchmark risk---is when I believe down-a-lot is by far the likeliest scenario.”
Nobody can predict market movements with precision. Most people can assign probabilities to four possible outcomes: Up-a-lot, Up-a-little, Down-a-little, or Down-a-lot. The probabilities may not be right, but they are what the investor believes. I agree with Fisher: Jumping out of and into the market and exposing your “investment” portfolio to massive Benchmark Risk by holding large amounts of cash in excess of your known 3-5 year cash needs, is essentially only wise if you are convinced that there is a very high probability of a “Down-a-lot” scenario.
After a real Down-a-lot happening, many choose to believe that “we should have seen it coming”. The word “should” and “could” are much different. Very few, if any professional investment managers would stipulate that anyone could have predicted the last six months of market decline with any degree of confidence. (Some things are un-knowable.) And, taking on big Benchmark Risk can be very costly. In other words, being “safe” in reality may be very risky. Managing risks is what life and successful long term investing is all about. Avoiding risks is a sure path toward lower than average returns.
You should be investing because you need long term returns that appreciably exceed inflation—increasing purchasing power. If you have enough without subjecting yourself to investment risks, then by all means buy more CD’s, short term Treasuries, and hold cash. Then, hope that high rates of inflation are only temporary.
History teaches that a future Down-a-lot scenario is less likely after a 50% market decline. So taking huge Benchmark Risk now is even more risky than usual. The reward is probably not worth the risk. The risk of Recency Bias is very high. What I call “going to cash” at the wrong time can make it difficult or even impossible for you to reach your long term goals or even to recover from the most recent downturn.
While taking on big Benchmark Risk is usually not wise, taking on some smaller risk in the form of tactical increases in sector allocations may be wise. The reward may be worth the risk. (This is part of the value received by active investment management.) Buy, Hold and Hope as an investment strategy may no longer be optimal. We are advising that most portfolios could benefit by overweighting in Energy and Health Care. Some form of hedging against the risk of rising long term interest rates and inflation may also be appropriate. (Call us for more explanation and how these strategies might apply to you.)
In addition, a re-evaluation of the correct Asset Allocation and Benchmark for you is also very appropriate. Circumstances change and your investment portfolio should be set up appropriately for you.
Where is the market going? History teaches us that it is going up. What we don’t know is when. We are telling our clients that there are two scenarios that are highly probable (but not certain). The first is “Investment Purgatory” for a couple years; the second is “Investment Heaven with Inflation” sooner than expected. We advise looking for long term investments that will do better than average in both scenarios. (Call us for more explanation.)
Nobody knows when this market turns. By the time that it looks certain that the market is going up, it will most probably have already risen by a great amount. Missing out will be more permanent than any temporary downturn. This is the real cost of Benchmark Risk.
This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.
See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.
You have already experienced the reality that the value of your investments will decline and that you will suffer unrealized losses. A Down-a-lot market surprise has happened. This occurrence is real and recent. There is a danger that you may make the error of Recency Bias, defined as the tendency to be excessively affected by the pattern of recent data. This is the first of what I like to call the “hidden risks of investing”.
The second risk is inflation. It has been a long time since we have experienced double digit inflation, but with huge government deficits and a lot of monetary stimulus, the risk is real. Cash and bonds perform poorly in an inflationary environment.
Another important risk to understand is defined as Benchmark Risk. Of all risks, this is probably the least understood by most investors. There are many fancy technical definitions and measurements used by professional money managers and academics, but the basic principle is reasonably easy to understand. The first step in constructing an investment portfolio is the selection of the correct Asset Allocation and the corresponding Benchmark for you. This can be a complicated process, but for the sake of discussion, let’s assume that one possible Benchmark is the well known general domestic all-equity market index known as the S&P500.
A Benchmark is the standard to which we compare results. Benchmark Risk is created when we deviate from the basic make up and character of that standard. For example, if our Benchmark is the all-equity S&P500 and we decide that our portfolio will move to all bonds and cash. In this case, we have created a risk that the performance of our portfolio may not be comparable to the Benchmark--and that we will not reach the intended long term goal. Here’s a quote from Ken Fisher in his excellent book that I recommend: The Only Three Questions That Count (John Wiley & Sons, Inc.- 2007) “The only time I am ever comfortable beating the benchmark by a lot—taking on massive amounts of benchmark risk---is when I believe down-a-lot is by far the likeliest scenario.”
Nobody can predict market movements with precision. Most people can assign probabilities to four possible outcomes: Up-a-lot, Up-a-little, Down-a-little, or Down-a-lot. The probabilities may not be right, but they are what the investor believes. I agree with Fisher: Jumping out of and into the market and exposing your “investment” portfolio to massive Benchmark Risk by holding large amounts of cash in excess of your known 3-5 year cash needs, is essentially only wise if you are convinced that there is a very high probability of a “Down-a-lot” scenario.
After a real Down-a-lot happening, many choose to believe that “we should have seen it coming”. The word “should” and “could” are much different. Very few, if any professional investment managers would stipulate that anyone could have predicted the last six months of market decline with any degree of confidence. (Some things are un-knowable.) And, taking on big Benchmark Risk can be very costly. In other words, being “safe” in reality may be very risky. Managing risks is what life and successful long term investing is all about. Avoiding risks is a sure path toward lower than average returns.
You should be investing because you need long term returns that appreciably exceed inflation—increasing purchasing power. If you have enough without subjecting yourself to investment risks, then by all means buy more CD’s, short term Treasuries, and hold cash. Then, hope that high rates of inflation are only temporary.
History teaches that a future Down-a-lot scenario is less likely after a 50% market decline. So taking huge Benchmark Risk now is even more risky than usual. The reward is probably not worth the risk. The risk of Recency Bias is very high. What I call “going to cash” at the wrong time can make it difficult or even impossible for you to reach your long term goals or even to recover from the most recent downturn.
While taking on big Benchmark Risk is usually not wise, taking on some smaller risk in the form of tactical increases in sector allocations may be wise. The reward may be worth the risk. (This is part of the value received by active investment management.) Buy, Hold and Hope as an investment strategy may no longer be optimal. We are advising that most portfolios could benefit by overweighting in Energy and Health Care. Some form of hedging against the risk of rising long term interest rates and inflation may also be appropriate. (Call us for more explanation and how these strategies might apply to you.)
In addition, a re-evaluation of the correct Asset Allocation and Benchmark for you is also very appropriate. Circumstances change and your investment portfolio should be set up appropriately for you.
Where is the market going? History teaches us that it is going up. What we don’t know is when. We are telling our clients that there are two scenarios that are highly probable (but not certain). The first is “Investment Purgatory” for a couple years; the second is “Investment Heaven with Inflation” sooner than expected. We advise looking for long term investments that will do better than average in both scenarios. (Call us for more explanation.)
Nobody knows when this market turns. By the time that it looks certain that the market is going up, it will most probably have already risen by a great amount. Missing out will be more permanent than any temporary downturn. This is the real cost of Benchmark Risk.
This commentary and information is provided for the benefit of clients and should not be considered a sales presentation.
See http://www.waynestrout.com/ for more complete info: Investment advisory services are offered by WS Wealth Managers, Inc., an investment adviser registered with the SEC. Wayne Strout is an Investment Adviser Representative with WS Wealth Managers Inc. in addition to serving as President/CEO and Chief Compliance Officer of the firm. Scott Sebring is an Investment Adviser Representative and Vice President. WS Wealth Managers Inc. is not affiliated with Glen Eagle Advisors LLC or Pershing LLC. Wayne Strout and Scott Sebring, dba WS Wealth Managers. Securities offered thru Glen Eagle Advisors LLC, Member of FINRA And SIPC, with clearing thru Pershing LLC, Division of Bank of New York Mellon Corporation, also Member of FINRA and SIPC.
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