The Best Investment Offense is a Strong Defense

We New Englanders surely are blessed with a lot of great sports teams that bring the drama and occasionally the championships to us, along with their share of heartache too. The Pats’ season got off to a rough start with a couple of ugly games that could have gone better, especially from the revisit of the AFC Championship game with the Jaguars.

Jill and I watched the game over a “friend of a friend’s” house in Plymouth with about six other couples. Let’s call our new friends Kevin and Marie. Kevin is my age, and a Tom Brady and Bill Belichick enthusiast. As we sat and watched the Pat’s defense crumble to the Jaguars offensive, Kevin couldn’t help to blurt out, “Come on Bill, you know the best defense is a good offense!”

Kevin may be right, and he got me thinking: While offense scores points, we all know that defense wins games. Without a strong defensive line to drive turnovers and secure good field positioning, our beloved Tom Brady is often left yelling in frustration from the sidelines.

Kevin and I got to talking. He’s seen his portfolio swell with investments in so-called FAANG stocks (Facebook, Amazon, Apple, Netflix, and Google), along with splattering of mutual and index funds. The Federal Reserve Bank of St. Louis noted earlier this year that Kevin’s situation is pretty typical.

Just like Kevin, somewhere around 62% of those middle-aged families polled said they were participating in the market. That’s a lot of combined household wealth concentrated in the stock market.

I listened for a bit as Kevin boasted to all of us who would listen about his gains over the past few years. That’s when I asked Kevin about his investments’ downside risk mitigation plan. He shrugged and said that he does not have one, it hadn’t been an issue up to now.

I learned from Kevin that the couple’s investment strategy boiled down to a very common retail brokerage type “buy and hold” or “buy and hope” strategy. While it may have worked okay for them since 2008, Kevin and Marie have a ton of inherent risk.

Kevin and Marie are about to potentially “fumble the football” at a critical point in their lives. Just like so many investors did ten years ago – including Kevin and Marie –when so many asset classes, including stocks and bonds, became correlated and dropped like rocks. It’s amazing how short some people’s memories are.

So, Kevin and Marie came to see me last week in my Duxbury office. We solved for their drawdown by back-testing their current strategy specifically through 2008. Drawdown is a measurement of an investment’s high to a low over time. Looking at Kevin and Marie’s drawdown was quite revealing.

You see, if Kevin and Marie were to stay with their current investment strategy through another “2008” type scenario, they could possibly see a 50-55% hit to their portfolio. It’s one thing to know how well you’re doing when momentum and field positioning is in your favor. It’s another thing entirely to see how you’d do if it is not. Kevin and Marie had only focused on the offense, or gain, of their investments without really understanding the potential downside risk, or loss, by not having a strong defense.

Hmmm . . . they are about to potentially fumble the football.

A 2008 scenario could devastate their savings. Just like it did when they were in their mid-40s, and now they are in their mid-50s. At a time when they are putting three kids through college. They cannot fumble the football this time around.

Just like a quarterback on the field calling for a time out to rethink his strategy, it’s essential for Kevin and Marie to take a careful assessment of where their investments are, where they need to be, and how to get there. An aggressive investment strategy with significant volatility may be appropriate for young investors, but over time investors’ needs change. That’s certainly the case with Kevin and Marie.

In football, you can’t get lazy or take your eye off what’s happening on the field even for a minute. A lot of the game is about the momentum and positioning of each team on the field: Both offense and defense seek to carry their own momentum forward while disrupting their opponents’.

I suggested to Kevin and Marie that they move towards a Risk-Budgeted Investment System (RBIS). A RBIS is rules-based and seeks to provide investors with a combination of tactical and strategic systems that helps them to stay invested, or on the field, in an asset class while momentum is on its side and call time out when it is not.

Just like Belichick and his coaches, the determination of that momentum is made by a careful analysis of data to help put the team, or Kevin and Marie’s case their investments, in the best possible position to win. So, when the momentum shifts away from an asset class, a rules-based system moves the investor’s portfolio to a safe harbor, or to the sidelines. Investors are thus able to capture much of the upside positioning while potentially reducing the downside risk help preserve capital.

By the time we were finished, we had reduced their drawdown from over 50% to under 20% percent. That helps to give them a much higher probability of financial success over the long term.

At this point in the game, Kevin and Marie hadn’t considered an investment strategy more appropriate to their long-term goals. In the next decade, they’ll be playing in the Red Zone, when they’ll pivot from wealth accumulation to wealth distribution.

A lot will need to happen between now and when Kevin and Marie retire, and it’s becoming a game of inches for them as they get closer to the goal line. They agreed that in times like these, with the clock running out, an appropriate investment strategy for them must be centered around capital preservation. They now understand that if you manage the downside, well, the upside should take care of itself.

When it comes to your finances, don’t fumble the football. Turn the conventional sports wisdom on its head. When it comes to your retirement investments, the best offense is a strong defense.

That’s why I always tell you to be vigilant and stay alert because you deserve more.

Go Pats! And Go You!

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, a wealth management firm with offices in Falmouth, Duxbury, and Mansfield. Jeff can be reached at jeff@cutterfinancialgroup.com.

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