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February 27, 2009

Perspective

Austin and I are going to be tied up in meetings most of the day today, but I did want to touch base briefly about something important.

We've been commenting on a lot of negative stuff lately, from government actions to market direction. There's lots of gloom in the investing world right now, and everyone's feeling it.

Dark times like these bring the greatest risk of plan-destroying emotional decisions. The pain has been high, there's little light seen shining at the end of the tunnel, and it just seems smart to pull your money out and head to the sideline.

Don't do it.

Despite the current gloom, some perspective is needed. With stocks down some 50% from their highs, investor reaction should vary quite a bit by age.

Anyone under 45 should be thankful for the market decline. This selloff hurts current portfolio values, for sure. But it provides a great opportunity to be pumping money in at these dramatically lower prices. With 20+ years until retirement, there's plenty of time for those seeds sown at these levels to grow as the market recovers. If anything, this group should probably be increasing their stock exposure, not decreasing it.

The 45-55 group likely feels the recent losses a lot more acutely, as they thought they were much closer to their savings goals, and with their shortened time horizon, it may be hard to see how the math is going to add up the way they thought it would. Still, in terms of what to do right now, this group still has enough time to reasonably expect the stock market to dig them out of this hole. Guarantees? No. But reasonable expectation? Yes. Selling here with the expectation of getting back in later carries a significant risk of its own, namely missing much of the upside that has the potential of erasing a significant portion of the recent losses. Missing that surge could be damaging for this group who may not have many of those surges left.

The 55-65 group is clearly the most severely impacted by the decline, but hopefully also had some protective measures in place by virtue of their asset allocation. This group has the most reason to consider further defensive measures at this point, as further losses from here coupled with their shorter time frame make the prospect of recovery less probable.

For investors in all three groups, it's important that any decisions made in the depths of this market gloom are made inside-out, rather than outside-in.

Being an inside-out investor doesn't mean you can never modify your plan. It doesn't mean having blind faith that everything will turn out fine in the end. But it does mean that when events change and you feel that defensive steps are in order, those decisions are measured and not emotional. Part of that likely means taking incremental steps rather than drastic ones. And all of these decisions should be made based on your portfolio, your time frame, your risk tolerance. Not what the market has done since the beginning of the year, the President's plans, or any external stuff.

I know there's been some confusion on this, given what we've been writing lately and the changes Austin has made in his own portfolio. But look closely. Austin is in that 55-65 group that is most affected by the recent downturn. He looked at all his internal factors at the beginning of the year, peeked at the external factors as well, and determined he thought the risk/reward ratio given his personal circumstances was tilted in favor of being aggressive.

When he changed his portfolio to make it less aggressive, it's true that adjustment was largely based on external factors, and that's what has been confusing to some. The key here is that the changes he made simply brought his plan back to "normal" from "aggressive." In other words, he basically just reverted to what his completely inside-out plan had him doing last year. These are incremental changes at the margin, not "should I be invested or should I sell and head to the sidelines" type changes.

Don't confuse making changes at the margin with abandoning core principles. We still absolutely believe you need to have a plan and be sticking to it. That doesn't mean you can never change anything. It does mean that if you make a change, you'd better have a well-thought out explanation that extends well beyond, "the market just looks so bad and I can't see when it's going to recover."

You need to think through what you're doing now as well as what you're going to do later. If you reduce your stock allocation now, what is going to trigger you to raise it later? The all-clear signal? If you switch to SMIVX with part of your Upgrading money now to reduce risk, is that a permanent move that makes sense given your personal circumstances, or is that something you're going to reverse later? If so, when? Based on what?

I'll continue to discuss some of these thoughts next week. Until then, don't do anything rash. Keep in mind that while things are still tough out there, and we may still have further downside to go, with the market 17 months into a bear market and already down 50%, history still says we're closer to the end of this thing than the beginning.