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Wintery Storm—A Pause For Reflection

I try to teach my kids to always be prepared for whatever comes their way.
 
Last week I had to practice what I preach. I went to Detroit for a couple of days to meet with another advisor. Seeing the weather reports, I threw some boots and some extra clothes in my bag, just to make sure that if I got caught in that wintery storm I would be prepared.
 
Lo and behold, I got caught in that wintery storm and was stranded there for a couple of days. And although I was disappointed and can think of many other places to be stranded than Detroit, I always try to look at a challenge as an opportunity.
 
With my workload and my desire to keep up with current events, I read a lot, but rarely have time to read for pleasure. So I took this opportunity to read what I like, The Wall Street Journal (WSJ).
 
This week, I want to share with you some of the excerpts from an article written a few years back by Tom Lauricella from the WSJ.
 
Mr. Lauricella wrote, “The frenzy of selling that sent stock and bond markets into a downward spiral over the past two weeks saw investors abandoning anything with the tiniest hint of risk.
 
“Small investors are frustrated that everything they have been taught about the market has turned out wrong. Diversification is not working—nearly every corner of the market is down significantly and much of the bond market is also in the red. A buy and hold strategy has been a waste of time, and money, over the past decade.”
 
Hmm. Buy and hold.
 
Mr. Lauricella further wrote, “Investors who thought they were getting into stocks at cheap prices just a week or two ago are staring at a kind of double-digit losses that can make them think twice about buying anytime soon.”
 
Stay with me here.
 
Diving deeper he wrote, “The toll has been especially heavy on investors in retirement or nearing retirement. Unlike the defined benefit plans of previous generations, which were better equipped to weather downturns because new money continued to flow in, contributions to a 401(k) plan stop when an individual stops working, so losses cannot be made up.
 
“That leaves 78 million baby boomers vulnerable to big losses at a time when the economy could be in for a lengthy period of woes.” Tom finishes his column by writing, “This is prompting many investors to rethink the risks of trying to grow capital instead of preserving it . . . The flight of individual investors could be a kind of panic selling that often marks the bottom of the market. An emotion-driven decline sometimes can reverse sharply. But that is not always the case.”
 
That article was written on October 13, 2008, and was titled “Investors’ New Mantra: Bye and Fold. No Place to Hide.”
 
You see, most of us have seen gains in our investments over the past year and most of us do not see any kind of wintery storm ahead. But what if we get caught in a storm, with no protection?
 
What if we are not prepared? What if?
 
I have no way of telling you with 100 percent certainty when this market will turn. But I can tell you that we could be just one tweet away. So, are you prepared?
 
This week, let’s review some questions that you need answers to, so you can be prepared for when the the next storm hits.
 
The first question is this: What amount of drawdown are you willing to accept, without becoming that emotional investor who will sell at the worst possible time? Drawdown is the measure from a high to a low, from peak to trough, of an investment during a defined period of time. The drawdown in the overall markets was about 58 percent between October 2007 and March 2009. Let’s quantify that for a moment. Let’s say you had 1 million bucks in October of 2007, if you had held onto what Mr. Lauricella describes as a “buy and fold” portfolio; well, that million bucks would have shrunk to about $400,000.
 
What if you were in your distribution years and you needed income?
 
Another question is this: what is your beta? Investopedia describes beta as a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
 
Let’s take the S&P 500. It has a beta of 1. So, let’s say your beta is 1.1. That means you should expect 10 percent more volatility in your portfolio than you may see in the S&P 500. However with higher risk, theoretically, comes higher rates of return. So, in the good years, you may see 10 percent higher rates of return, because you are taking on 10 percent more risk.
 
But what if you roll into some bad years?
 
I have said it before and I will keep saying it: you cannot talk about gains without talking about losses. So, if the S&P 500 has a drawdown of 58 percent, could you expect a drawdown of about 64 percent? Quite possibly, yes. Are you comfortable with your current beta?
 
The final question is this: What were the results of your investment strategy during years such as 2001, 2002 and 2008?
 
You need to understand the behavior of your investments during years such as those, so you can be prepared for that wintery storm that quite possibly could be just one tweet away.
 
If you don’t get answers now, while the sun is shining—well, you may find yourself knee-deep in snow without good boots.
 
Folks, be vigilant and stay alert, because you deserve more.
 
http://tinyurl.com/lrla4gc