How Worried Should You Be?

By J. David Lewis

There is little doubt virtually everyone who gets this email is well aware of recent turbulent markets.  At the end of June 2011 the S&P 500 Index returns were 30.69% for twelve months, 2.94% for five years and 2.72% for ten years.  Stock market values dropped sharply around the beginning of August and have been volatile since.  When I started drafting this text, markets had been sharply down for several days.  As I draft and edit, they have rallied.  The bulls and bears are still in their struggle.  These alternating good and bad days have been the nature of things for about sixty days.  For September 30, S&P returns were 1.14% for twelve months, -1.18% for five years and 2.82% for ten years.  It is not surprising a lot of people feel something must be done on the worst days of the down periods.  There is more to money than money®.  And, there is more to this situation than just making a few trades.   

During the recent quarter I had a conversation with another investment advisor, in which my friend asked about our portfolio adjustments in light of the markets.  This is not an unusual question.  I see several broadcasted emails a week from reporters wanting the same kind of commentary.  When I told my friend we believe in building portfolios we are satisfied to hold through tough times, he concurred that our philosophy is correct in terms of investment management. The disturbing part of the conversation was his explanation for their recent portfolio changes.   

My friend was concerned about calls from distressed clients.  He felt compelled to show them account activity to maintain their relationships.  In effect he said, “I don’t know whether what I am doing will improve investment returns or not – probably not.”  I felt he was noticeably uneasy that he was making changes solely to soothe clients.  When I described the conversation in our office, we all felt gratitude for our client relationships.  We do not feel the pressures that seem to prompt many advisors’ departure from their belief that well diversified portfolios should not be disturbed based on recent market events.  Unfortunately, I think many advisors do a lot of things to appease clients’ moods instead of well informed investment reasoning.    

We think it is important to help clients consider their securities portfolio in the context of all their resources.  It is not unusual to see someone very concerned about stock market events when all the stocks they own are a relatively small portion of their total assets.  For some fortunate people, pension and social security income cover a large percentage of their day-to-day cash needs.  Therefore, the cost of their lifestyle does not require much from their portfolio, and probably never will.  Yet, they feel considerable emotional stress from market volatility, without considering whether the portfolio is already prudent for their situation.  Possibly you can feel at least some relief by just putting your exposure to stocks into perspective relative to the rest of your resources.  Try to understand the true significance of market volatility to your personal situation.  

With this line of thinking as our context, we consider ways to create portfolios we are comfortable holding during tough market conditions.  Periods of volatile markets are virtually a certainty in the future.  They are also generally some of the worst times to change investment allocations.  Facing the fact that there will be tough markets helps develop better portfolios.   

Regularly, we merge all a client’s accounts into one portfolio listing, where mutual fund names and categories are together in a logical order. This yields a rough impression of the client’s exposure to stocks in general and various types of mutual funds.  At this level of review, we consider diversification and portfolio behavior characteristics we can reasonably expect.  Other times we create more sophisticated reports to understand allocations from different perspectives.  Because mutual funds that appear to hold U.S. stocks almost always have bonds and non-U.S. stocks, it is important to see allocations to specific types of instruments without regard to the mutual funds that hold them.  Often this deeper research reveals different allocations among instruments than the mutual fund names imply.   

With this array of tools, we can analyze how a portfolio would have behaved through the ups and downs of the past ten years, which has an unusually rich assortment of ups and downs.  This sense of portfolio resilience can go a long way toward revealing how damaging market events might really be.  We know there will be tough markets that will affect our clients’ securities portfolios.  The issue is to develop a sense for how much they will be affected.  We believe strongly that the perspective and judgment these rigors bring is far more significant than the latest news stories. In our view, changing portfolios to imply we are reacting to recent events and news seems deceptive.   

I hope this summary of our philosophy helps you understand how significant this, or any, turbulent market is for your total resources – not just your 401(k) and other investments.  It is likely you are personally less vulnerable than you may feel.  Of course, we will welcome the opportunity to give our professional opinion of your specific financial strength.   

Contact J. David Lewis directly with dlewis@resourceadv.com or share your thoughts on this topic below. He founded Resource Advisory Services in 1985.  National Association of Personal Financial Advisors (NAPFA) was formed only a few years before. Lewis became a NAPFA-Registered Financial Advisor in 1986.  He is a passionate advocate for fiduciary, fee-only financial planning and has been associated with financial services since childhood in a banking family.  55585

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