When the Music Stops, Will You Have a Chair?

Musical ChairsI recently saw an ol’ Mass. Maritime buddy of mine when he visited the Cape for a long weekend with his girlfriend, I’ll call him Austin. Austin and I have known each other for almost 30 years. The two of us were shipmates together after graduation – he as a mate and me as an engineer. I had not seen him in about 15 years, so it was great to see him and catch up. After hearing what Austin has gone through over the last 15 years, it reminded me of how important it is to use a disciplined approach to manage both your income and your assets.

After shipping out, Austin’s passions led him to a lucrative career in publishing. He ended up in New York City. Things were going very well for him until 2008, when the economic downturn and the changing nature of the media market hit his business hard. In rapid succession, Austin lost his job, lost a significant percentage of his net worth as the markets got pummeled, and found himself underwater with a mortgage and other expenses he couldn’t afford. Austin eventually lost his house and his marriage sank.

Austin has always been a fighter. I often saw him overcome adversity while at Mass. Maritime and at sea. So, it was not surprising to hear that Austin rebuilt his life . . . but it took some time and a lot of desire and determination. He relocated to St. Louis, where he’s now teaching high school kids the principles of graphic design and publishing.

Austin is very happy with his new profession and finds it incredibly fulfilling, however, the money isn’t anything compared to what he was earning before. He had to radically change his lifestyle. Austin doubts that he’ll ever be able to rebuild that nest egg he lost a decade ago. For Austin, the rest of his working life and his retirement look very different than they did before 2008.

Austin is hardly alone. According to a recent report I read from Transamerica Center for Retirement Studies, about 56 percent of respondents said they have not yet fully recovered from the 2008 economic downturn. Of those folks, 37 percent say they’ve somewhat recovered, 12 percent say they haven’t begun to recover, and 7 percent say they may never recover.

While we may still be in a period of strong economic and market growth for now, that growth won’t continue forever, at some point the music will stop. You see, a complete market cycle (or a full market cycle) is defined as a period of bull, bear, and bull periods generally lasting 4-5 years. Historically, the average full market cycle is 56 months. Last week marked the 9th year of our current bull market.

At some point, something has to give. The question is, how well are you prepared when the music stops?

I encourage our clients to have a clear vision of both short-term and long-term goals. What do you want to accomplish over the next three, five, and 10 years? Understanding how your income and investment systems will help you get there is critical. Do you have a plan in place? If not, don’t you think now’s the time to start?

In 2008 Austin lost his job. He collected unemployment and sought other work, but his income didn’t even come close to covering his expenses – a condo in New York City and the requisite lifestyle that he thought city living demanded. While things were good, Austin was able to keep up with an expensive lifestyle. When things weren’t good, Austin found himself almost immediately dipping into retirement savings to help pay the bills. Retirement savings that had already seen a deep nose-dive in value because of the weakened economy and his investment strategy.

Austin might have been able to avoid tapping his retirement savings to live on if he’d had more of a war chest to ride out the bad times. But he didn’t. He was living an aspirational lifestyle – paying less attention to what was going out and more on keeping up with the “Joneses” – a luxury car, the right gym membership, outings to trendy restaurants and extravagant vacations.

Austin had no budget. Austin had no plan.

In fact, U.S. Bank reports that only about 41 percent of those surveyed use a budget. Like Austin, most people wing it.

Austin was also employing the classic “buy and hold” asset allocation strategy for his investments in 2008. Buy and hold appeals to some investors because they think it’s easy to implement. As I tell my girls at home, just because something is easy it doesn’t make it right. Austin’s strategy was just deposit money, don’t freak out when the market tanks, and eventually you’ll be ok. But what if you’re not? What if it does not work that way?

According to DALBAR (an independent research firm) the two biggest problems individual investors face are “loss aversion” and the “herding effect.” Loss Aversion is the fear of loss which leads to a withdrawal of capital at the worst possible time, also known as “panic selling.” Herding is following what everyone else is doing. This leads to “buy high/sell low” – that’s a foolproof formula to lose money.

These two behaviors tend to function together, compounding the issues of investor mistakes over time. As markets rise, individuals think that the current price trend will continue to last for an indefinite period. The longer the rising trend lasts, the more ingrained the belief becomes until the last of “holdouts” finally “buys in” as the financial markets evolve into a “euphoric state.”

As the markets decline, there is a slow realization that “this decline” is something more than a “buy the dip” opportunity. As losses mount, the anxiety of loss begins to mount until individuals seek to “avert further loss” by selling.

The solution is, of course, to implement a rules-based investment approach that employs facts and logic. A tactical and strategic investment strategy whose primary focus is to manage the downside to help preserve capital in times such as 2008, when Austin absorbed over a 40% hit to his investments.

Hmmm . . . 2008, the year the music stopped, and Austin couldn’t find a chair.

Austin had no choice but to withdraw from his deflated assets further setting him back. Just another critical mistake that my shipmate could have avoided if he’d had the foresight to save or have investments that had built in risk triggers to help preserve capital.

My ol’ shipmate Austin doesn’t regret the mistakes that he’s made. He’s learned a lot from them, and he’s not making the same ones again. He’s had to radically rethink the life he has now and the life he’ll have in retirement. He lives within his means, and uses a rules-based investment strategy to help take advantage of most market upswings while reducing exposure during market downswings.

The next time the music stops Austin will have a chair, will you?

Be vigilant and stay alert, because you deserve more.

Have a great week!

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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