A Pre-Mortem Autopsy For Your Portfolio

32366679 - four red dice with colored casino chips isolated on white background with reflectionI’m not much of a gambler; I really never have been. I’ve been to plenty of casinos over my almost 49 years, but I have a very, very hard time putting my money on the table. I guess I am inherently risk averse, but there is one game that I have a hard time resisting…and that is craps. Have you ever stood by a craps table while your friends played and just watched? It’s easy to sit back and relax as a spectator when the dice travel around the table, and the game goes up and down. However, when someone gets on a roll, and the whole table cheers, and your buddy’s stack of chips starts to grow, it’s an entirely different story. Then, it’s not as easy for me to remain a spectator.
When that happens, I find my hand in my pocket, fumbling around with the chips I have tucked safely away. I wiggle my way closer to the table until I am bellied up to my betting spot. And as the cheers get stronger, so does my overzealous enthusiasm, and I decide I’m crazy for not playing. Thoughts race through my head: “Everyone is winning around me! I have to get in there! There is no way I can lose! I am missing out!” I put my chips on the table and just about every time, my chips are gone in the first round, and I leave a loser. But, I cannot help myself…and folks, neither can millions of investors. It’s what we call performance chasing, and those who are guilty of chasing performance pay for it, more times than not.
I had two different couples come to my office recently; both were in a similar financial situation. Each was holding a couple million bucks, all in cash. This money, in a combination of bank accounts and money market accounts, has been earning as little as one one-hundredth of a percent annually. One couple retreated from the stock market in the spring of 2009, locking in losses. The other exited the markets during the volatility in the summer of last year. Both of these couples, with appointments separated by just a few weeks, were feeling it was time to move back into the stock market, as it hit near record heights again. They had forgotten the pain they previously experienced and wanted to get back in the game.
I wrote an article a few weeks ago about managing market volatility (http://tinyurl.com/zpagwex). So far, in 2016, the markets have been unpredictable at best, extremely volatile at their worst. In the wake of this performance, many investors are fleeing in a scrambled panic, evidenced by the higher trading activity we have seen in the past few months as many investors try to escape feared equities to find safer investments.
But then there is also the group of investors who have been out of the markets since they imploded in 2008 into 2009. Those investors were shell-shocked and did what many retail investors do; they sold at the worst possible time. But, now, less than a decade since the Great Recession, those people are already starting to forget the pain. It is this group that needs to remember the US stock market dropped 57 percent between October 2007 and March 2009. Remember how much that hurt?
Folks, if you think that we are safe from this type of volatility in the future, you are wrong. And if you think you won’t panic when it happens, you are likely wrong again. Consider how you felt with the recent Brexit vote. How did you react? How did you feel?
On the other hand, when we are on the sidelines, we often get that feeling of wanting to see our chips stacking up like those around us. That feeling causes many to buy into the markets at the worst possible time.
So what can you do to help avoid both the panic and the euphoria that cause many to make these emotional decisions? Well, Gary Kline, a senior scientist at MacroCognition, thinks he has the answer. He works in Washington, DC, to help government agencies improve their decision-making processes.
Hmmm…that must be a tough job these days.
But, seriously, what does he recommend? He says to imagine the worst.
Imagine that the market crash of 2008 hits again in 2016 and your portfolio takes a 50 percent drop. What could you have done with your portfolio to prevent it? What actions could you have taken to keep your money safe? What was your strategy? They say hindsight is 20/20, so use the lessons you learned from 2008 to analyze your current decision-making process.
I recommend that you do this with your adviser: Imagine the worst and use his or her expertise to help determine the causes of a potential portfolio failure. Does it lack diversification? Does your portfolio’s risk profile not match your risk tolerance? Look back at your holdings in 2008-09. Have you positioned yourself better than you were then? Do you have a rules-based strategy? If so, what are the rules? What determines if you are in the markets and what determines if you are out?
Folks, this exercise is called a “Project Pre-Mortem,” because instead of letting the failure occur again, and then looking at what happened, you can imagine the potential causes for the failure and help to protect yourself from them. You can create a strategy.
Think of it this way: Would you rather die and be examined to find out why you died, after the fact? Or, would you rather get regular checkups and discover ways to prevent this death, before it happens? Seems obvious to me.
I think I am calling Dr. Hannah now for my checkup.
Be vigilant and stay alert, because you deserve more.