A few weeks back Jill and I were having a bite to eat at Soprano’s at the Casino Wharf in Falmouth. Jill and I like to sit at the bar: It is fun and friendly, and we can watch Scottie the bartender make his magical cocktails. Not to mention the food is delicious.
I got talking to the folks next to us, let’s call them Will and Betty. Will and Betty are 65 and 68 respectively, have two daughters who are married. One lives close by with her two daughters. They are Italian immigrants who used to own a very successful restaurant in the North End before selling and retiring to Falmouth.
Will told me with a sense of accomplishment that his family arrived with the clothes on their back and $35 his father gave him before coming to America. While Will doesn’t cook to make a living anymore, he still loves to prepare food for the family.
Will’s granddaughters are 10-year-old twins, Lisa and Dina. The girls are full of laughter and mischief, always getting into something. Will told me a story recently about how the twins were at their house making lasagna, one of their very favorite recipes of their grandfather’s. “It’s a process, a recipe is all about following the rules,” Will said. He starts with handmade pasta, fresh ricotta cheese, sausage, and other delicious ingredients.
Lisa got impatient because the lasagna was taking too long to cook. When her grandpa wasn’t looking, she turned up the heat on the oven, even though she knew better than to touch it without her Nonno’s permission.
Unfortunately, the lasagna burned before Lisa’s mistake was corrected. It filled the kitchen with smoke and caused a brief panic. Everyone was okay, but dinner was ruined. Will gave the girls an important lesson about cooking: You must let delicious food cook in its own time – turning up the heat too fast will burn what you’re making. You just end up hungry.
We got talking about the markets. Will watches the financial news, so the recent tumult on the stock market caused him – and many other investors – great concern. Will said that the news he’s read suggests two factors played into Wall Street unease: The fallout of the United States’ ongoing trade dispute with China and what the Federal Reserve is doing with interest rates. Even the President has called the Fed’s rising rates his “biggest threat.”
Let’s look at what’s going on. At the end of September, the Fed raised interest rates from 2% to 2.25%. That’s the eighth time they’ve raised them since December 2015, when the rate was an all-time low of just 0.25%, where it stayed for years following the 2008 economic downturn. The Fed’s chairman, Jerome Powell, said that this effort will continue into 2020 and that rates will eventually reach 3-3.5%.
Will’s worried that this may signal an end to the bullish equities markets, where he’s made positive gains in the past several years. He’s worried that what happened in October may be a precursor of more instability to come.
Rising interest rates can put a damper on economic expansion. Rising rates make it more expensive for everyone to borrow money, whether it’s a business planning a major expansion or a couple buying a house. But even with Chairman Powell’s stated plans, short-term rates will still be well below their historical average of around 5% for quite some time to come.
In my opinion, this indicates that Chairman Powell is being pretty careful about not turning up the heat on the economic oven – he doesn’t want our economy to burn. At a conference in Jackson Hole over the summer, Powell said that a gradual process of raising interest rates is appropriate given the circumstances. He wants to avoid making the mistakes of the past when the Fed’s monetary policy has navigated “between the shoals of overheating and premature tightening.”
President Trump sees the Fed’s interest increase as getting in the way of hastening economic growth, but the President and Congress have already given the American economy a big shot in the arm with tax incentives and other deals.
Meanwhile, Chairman Powell is sensitive to the fact that he doesn’t want to burn the lasagna. He doesn’t want the rest of us to go hungry.
The past couple of years have seen significant economic stimulus thanks to tax reform and other incentives. And Powell considers the current course of the Fed to be an appropriate course of action based on the country’s current growth in income and jobs.
My new buddy, Will, on the other hand is concerned that drops of hundreds or even thousands of points throughout days or weeks is something that he won’t be able to recover from. A perfectly understandable concern. After all, Will some time ago transitioned from wealth accumulation to wealth distribution, and he can’t afford a setback as he experienced 10 to 15 years ago.
Will doesn’t have any control over what the Federal Reserve Chairman chooses to do with interest rates, or how Wall Street analysts or the President himself perceive such changes. But Will does have control over his investment strategy. It is essential for Will to have an strategy that can help to react to changing market conditions.
From our discussion, his investment strategy behaves more like “buy and hold” than following rules. He’s been enjoying the rising markets for several years with little thought about his potential downside risk. You see, buy and hold is a traditional asset allocation strategy used by many investors and those who, like Will, all too well remember the pain of holding on to long and getting burned.
I explained to him that employing rules, rather than gut instinct, is a disciplined approach to investing that helps to protect your investments from market downturns while still potentially capturing upside gains. A rules-based system employs tactics and strategies to take advantage of market momentum when it’s in the investor’s favor while moving investments to other asset classes when momentum turns against them.
Such a system can include triggers tailored to the individual investor, based on their level of comfort with risk. Quantitative data helps guide these decisions, rather than just gut instinct.
Will is at a point in his life where he can’t afford setbacks of 40-50%. He doesn’t have time to recover from another downturn like the one he experienced in 2008, or 2001 and 2002. By introducing an appropriate rules-based investment system, Will can reduce his potential downside exposure from 40-50% to a much more manageable 15-20% – a level of risk he felt much more comfortable with.
That gives Will more time to cook with his granddaughters – and to keep an eye on the oven temperature to make sure no one is getting impatient and the lasagna doesn’t get burnt.
Be vigilant and stay alert, because you deserve more!
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 email@example.com.
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