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Rules For Post-Recession Investing
by Rob Gordon and Jason Whitby, www.investorsolutions.com (Contact Author | Biography)
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Filed Under: Active Trading, ETFs, Options, Recession, Stocks
Despite the pundits' pronouncements of green-shoots or signs that the economy is on the mend,
many investors remain scarred and understandably sensitive to the previously unimagined
threats to capital market stability. In many cases, not only have they reduced their equity
exposure to levels that will not help them beat inflation, many have pulled out of the publicly-
traded markets entirely, and remain on the sidelines.
Return to Investing
If you are planning to retire on the assets you have accumulated or are accumulating, you need
to get exposure to the equities markets and you need to do that sooner rather than later. Global
4. equities markets work and you deserve your share of the positive long-term returns they
generate.
Generally, market declines cause panic, to quote a study by DALBAR - a leading developer of
measurement systems for intangibles, such as customer behaviors, in the financial services
industry. A 2003 study by DALBAR found "motivated by fear and greed, investors pour money
into equity funds on market upswings and are quick to sell on downturns." The report goes on to
say that in the past 19 years, the average equity investor has earned 2.57% annually compared
to 12.22% for the S&P 500 Index. This study clearly illustrates the "reactive" nature of today's
investors and just how much it costs them in return. It's important to recognize how much
emotions influence investing decisions most often to investors' detriment.
Keys to Excellent Returns
As investors slowly emerge from their fear-induced stupor, it is important to review important
principles which have provided excellent risk and inflation-adjusted returns over the last 50 or
more years. With these foundational principles in place, the investor will be ready to participate in
the global capital markets.
* Don't Forget About Your Risk Tolerance
Return statistics are perhaps the most quoted numbers in personal finance and investing.
Quantitative measures of risk or volatility are undoubtedly the least quoted. When you look at
your risk tolerance, consider three factors: capacity to take investment risk, need to take
investment risk and desire to take investment risk. There are many questionnaires and other tools
online that attempt to help investors measure these variables. Use them as a sanity check for
your own measures given your previous investment experiences.
* Draft and Sign an Investment Policy Statement (IPS)
Institutional investors, like pension funds and university endowments, have a document which
defines the types of investments allowed in their portfolios. Good fiduciary investment managers
have an IPS for each of their clients. An IPS takes all the relevant inputs and creates your own
personal investment plan and diversified asset allocation. Essentially, the IPS helps you stick to
the plan and tells you what to do when in doubt.
* Keep The Investment Decisions Simple
With an IPS in hand, you now have specific marching orders to populate your portfolio with
actual securities. Index mutual funds and exchange-traded funds (ETFs) reduce costs and
provide broad exposure to specific asset classes. To my knowledge, no one has been able to
"beat the market" year in and year out, so active investment management is not a reasonable
option. Keep costs low and stay invested. That is how the race is won and your goals are
achieved.
These are foundational steps in the construction of your portfolio. The next question is, "How
should you get back in?" This question essentially refers to the two primary options: put it all in at
once or stage the money in over time. Which is best?
All at Once
For investors who have just experienced one of history's most challenging economic periods, this
option must seem the least interesting. However, in a world where market timing does not add
additional return and where the expected returns are positive, it makes the most sense. Any
averaging-in strategy will keep money out of a rising market. Nevertheless, averaging techniques
remain very popular in the financial press and in practice. The reason for this is primarily because
it feels good.
Averaging Into the Market Over Time
If you accept that you need exposure to the equity markets, there is a high probability that you will
consider averaging into the market versus making a lump sum investment. Given that likelihood,
what is the best way to average into the market? Quite simply, it depends on larger financial
planning concerns like your need for cash and outstanding obligations. Beyond that, the options
5. are innumerable: contribute a set amount; a set percentage of the remaining balance; a fixed
dollar amount; a variable amount based on fluctuations in the market; a variable amount on a
random schedule and on, and on. Here are a few important considerations as you consider your
strategy:
* Formalize the plan by writing it down.
* Be careful of executing too many trades thereby incurring very high transaction costs. The
research overwhelmingly states that the benefits are marginal at best and most likely are
negative, so don't erase the emotional benefit by piling on hundred or thousands of dollars of
trading fees. No-transaction fee mutual funds can be beneficial in this area.
* Be careful of dollar-cost averaging up. If the market is rising, you will be buying higher and
higher levels. Remember, the market has had, and we expect that it will continue to have, a
positive bias as global economies continue to rise. If you divide your investment into too many
pieces, you will end up investing the money over an ever longer period of time and therefore
increasing the probability of dollar-cost averaging up.
* Try to divide the investments among the least correlated assets. For example if you are going
to invest $10,000 into five different investments, try to pick U.S. large cap, international large cap,
commodities, real estate and maybe fixed income.
Conclusion
No one really knows when it is "safe" to get back into the markets, or whether the market is
experiencing a dead cat bounce, sucker rally, V-shaped recovery or W-shaped recovery. You will
not receive an email, phone call or other advance notice saying, "Now is the time!" More than
likely, when the news is rosy and you start feeling safe about getting back in, you will have done
irreparable damage to your ability to keep pace with the market. Do your best to keep emotions
out of your investments and jump in.
by Rob Gordon and Jason Whitby (Contact Author | Biography)
Rob Gordon, CFP, AIFA, has worked in personal financial planning and investment management
for 10 years providing financial planning and investment management for a wide variety of clients
and institutions. He also spent four years as a commodities trader with British Petroleum.
Additionally, his professional experience includes work in economic development with the U.S.
Peace Corps in Central America. He has a Bachelor of Arts degree in economics from Dartmouth
College and an MBA from the Darden School at the University of Virginia. He is a Certified
Financial Planning practitioner (CFP) and an Accredited Investment Fiduciary Analyst (AIFA).
Jason Whitby, CFP, CFA, MBA, AIF, has been working in the financial services industry since
2001, providing financial planning and investment management for high-net-worth clients and
institutions. His prior experience encompasses security research, portfolio construction and risk
management. Prior to his financial services career, Whitby was employed in the semiconductor
industry working in engineering, sales and finance. He has a Bachelor of Science degree in
chemical engineering from Purdue University and an MBA from Santa Clara University with a
concentration in finance. Additionally, he is a Certified Financial Planning practitioner as well as a
Chartered Financial Analyst and an Accredited Investment Fiduciary.
Filed Under: Active Trading, ETFs, Options, Recession, Stocks
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