Foster Group

Turbulence ahead?  Better check your gauges.

 

“A thunderstorm is never as bad on the inside of an airplane as it appears on the outside.  It’s worse.”

Accepted pilot wisdom

 

Turbulence - it causes stomachs to flip-flop while traveling through storms in airplanes as well as when trying to ride out investment markets during times of economic uncertainty.

 

When pilots engage in steep turns they can experience vertigo which, in the extreme, can feel like a straight and level descent when the plane is actually plummeting in a tight, ever-steepening turn known as a “graveyard spiral”.  In the book “Mastering Instrument Flying,” would-be pilots are reminded that when they are flying at night, or in turbulence, they may experience

 

 “…vertigo, or spatial disorientation as it is technically called.  One cardinal rule for coping with any kind of vertigo, dizziness, or confusion between what your eyes see on the instruments and what your senses are telling you is trust your instruments.  Accept the fact that in many circumstances the senses are wrong when the instruments are correct. When flying by reference to instruments, the eyes are seeing symbolic rather than actual references.  The input is not as strong nor as vivid as the real world.  Other senses – particularly the motion senses – tend to take over the eyes' role.”

 

Note that the vividness of how we “feel” makes it very hard to trust the instruments and to act in accordance with what they are telling us about reality.

 

Pilots rely on altimeters for altitude, attitude indicators for staying level with the horizon, and directional gyros for course correction.  Wouldn’t it be helpful if there were gauges for the condition and performance of investment portfolios?

 

While there are no fool-proof indicators, there are at least five “gauges” that any investor can, and should, check often, regardless of the economic turbulence.

 

1. Directional Gyro

“Never let an airplane take you somewhere your brain didn’t get to five minutes earlier.”  

 

Do you know the goals or “destinations” of your investments?  When do you need to access money from the portfolio?  How much and for how long?  These are very basic, but important, questions that can be answered within the context of a financial plan.  Before we send our money on a journey, we should know where and when we want it to arrive!

 

2. Fuel Gauge

“The only time you have too much fuel is when you are on fire.”

 

In our earning years, when we are converting our human capital into financial capital, how much human capital we have left can represent the amount of fuel in the financial tank.  The more earning years remaining, along with the prospects for increasing pay, the longer we can stay in the air, until we choose to land (retire). 

 

In retirement, fuel can be represented by liquidity.  How many years of living expenses do we have in cash and conservative fixed income?  If you need $100,000/year for lifestyle expenses, then $800,000 of short-term (1-2 year maturity) high-quality bonds and cash means you have, at minimum, 8 years of fuel. This liquidity allows investors to ride out equity market turbulence, waiting for better times to convert stocks to cash.

 

3.  Airspeed Indicator 

“A fool and his money are soon flying more airplane than he can handle.” 

 

To make the portfolio perform at higher rates of return (go or grow faster), investors have traditionally looked to stock-type investments.  But all stocks are not created equal in terms of expected and observed returns.  While there are many ideas being thrown around today, three factors still stand out as academically-supportable ways to increase the probability of higher portfolio returns over the long term (10-20 years).

 

• Factor 1: The Market.  Favor stocks (“the market”) over cash or traditional bonds.
• Factor 2: Small vs. Big.  Favor small company stocks over large company stocks.
• Factor 3: Value vs. Growth.  Favor value company stocks over growth company stocks. 

 

Investors who emphasize these factors, in a broadly diversified portfolio, have historically achieved higher returns over periods of 10 years and longer.

 

4. Altimeter

“If speed is life, altitude is life insurance.  No one has ever collided with the sky.” 

 

One thing that investors seem to be learning (again) is that no one can reliably predict the future, especially the near-term future, when it comes to investment market direction. If that’s true, then broad diversification in our portfolios is like having lots of altitude while flying.  If some of our investments do poorly when they encounter a turbulent stretch, we have many other types of investments in the portfolio to keep us in the air.  US large and small companies, foreign large and small companies, emerging markets, real estate, bonds, cash, and insurance contracts all represent types of diversification available to investors today.

 

5. Artificial Horizon / Attitude Indicator

“Accept the fact that in many circumstances the senses are wrong when the instruments are correct.” 

 

A good Investment Policy Statement (IPS) describes the long-term goals of the portfolio in terms of return requirement, potential risks, liquidity requirements, acceptable investments, the underlying principles of the portfolio’s management style and how success will be measured.  When these are in place prior to “take-off”, investors have a much better chance of surviving the turbulence that they are certain to encounter.  They can refer back to the IPS and see that turbulence was an expected condition, and that their financial plan and portfolio were prepared for it. If we have carefully chosen and calibrated our instruments prior to take-off, they can see us through even a very rough ride.

 

If, during this very turbulent time, you’ve been feeling like your investments are going in the wrong direction or that you need some gauges to check, perhaps a meeting with your financial advisor to discuss these ideas and your financial plan and portfolio is in order.  At Foster Group, we are offering a “Second Opinion” to investors.  We will review your financial plan and current financial condition along with your portfolio, at no charge or obligation to you.  We will then present you with an evaluation, our “opinion,” regarding the general “flight-readiness” of your investment portfolio and overall financial health.  You can learn more about our Second Opinion offer at www.fostergrp.com/second-opinion.