Dollars & Sense February 2014
Q. I’m worried about giving back all my recent gains, but my financial advisor never seems to sell. I lost big time in 2008 and don’t want to do that again. Isn’t there something I can do?
A. You’ve asked the million dollar question that is on most investors’ mind right now! Many investors suffered 25% or bigger losses in 2008 and it has taken them 4 or 5 years to get back to even or slightly ahead. But they haven’t forgotten that sick feeling they had in 2008 and they never want to experience it again. It sounds like you’re one of them.
Professional money managers, myself included, are generally trained to follow a similar path. We’ve all studied “Modern Portfolio Theory” (MPT), which was “discovered” back in the 1950s. Its creators even won Nobel Prizes, so it must be right, right? The cornerstone of this investment theory is that there is an optimal mix of investments that can maximize returns for a given level of risk. What that means in practice is advisors focus on optimal “asset allocation” and recommend diversified portfolios to match. Then they essentially “buy & hold” trusting Modern Portfolio Theory to work over the very long term.
The problem with this traditional way of investing is that it assumes investors are rational, that they can withstand the shorter-term volatility, and will stick to the plan for decades. Furthermore, these advisors swear that you can’t “time the market” and consistently know when to buy low and sell high. You just have to allocate, trust, and ride it out. I say nonsense.
Saying nonsense is akin to blasphemy in my field and goes against probably 90% of my fellow advisors. Sorry, but that’s how I feel and what my 30 years of experience tells me. I still wholeheartedly believe in the premise of risk management and asset allocation. That’s absolutely the right starting point. But I do not believe that one has to buy & hold and stay fully invested at all times. That’s like dressing for the long-term average weather and standing outside through blizzard and summer. You know you’d only be comfortable about 3 months a year!
So enough about theory, what can you do for protection from the big drawdowns and losses. The first step I would recommend is to manage your allocation using percentage ranges, not absolute percentages. Let’s say that you have a portfolio with 25% Bonds and 75% Stocks. Maybe you’re using individual stocks or maybe you’re using several mutual or index funds. It doesn’t matter. Rather than hold a fixed 75% in Stocks, perhaps a 50% – 75% range would work for you.
The second step is the critical one. You have to have a strategy that tells you when to be 50% stocks and when to be 75%. And if you can’t do this or don’t want to, then your financial advisor needs to do it. There are several strategies you could use based on fundamentals and valuation or based on technical indicators. ValueLine Investment Survey reports every week a “market appreciation potential” figure. When it’s low (like it is today!) it’s suggesting stock returns will be low going forward. Using ValueLine fundamental research, you might then move to 50% stocks. You could also use technical indicators (charts). A simple strategy for the “do-it-yourselfer” might be to stay invested until a broad stock index crosses over a long-term moving average, like the 200-day moving average. When the index crosses below the moving average, sell down to your 50% stock allocation.
So what can you do to avoid another 2008, or at least reduce the risk? Allocate using ranges, and manage the range using fundamental or technical indicators. If that’s too much, then find a financial advisor who does have this view and the tools to execute. Dress your portfolio for the appropriate season.
Ryan Investment Management (RIM) is an SEC-registered investment advisory firm based in Aspen, Colorado serving individual investors and non- profits. Our strategy is called “iFoliosTM” – index fund portfolios actively managed for growth and protection. More information is available at www.ryaninvest.com or (970) 429-1100.