This is an open letter to Daily Kos readers. For those who don't know me, I am an investment advisor for one of the major investment firms on Wall Street. Life in my world (helping clients navigate this environment) has not been easy. If you're having many doubts, possibly this letter will help.
~Ken
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Dear [readers]:
There is no doubt about it, we are living through extraordinary events. This diary is not to re-hash the news to you, but to remind of you a few basics of investing.
When we originally "met", I went through a tutorial on market cycles. All of those cycles included ups and downs, and some cycles included wonderful bull markets and others experienced terrible bear markets. We are in a terrible bear market presently. The month ending 9/30/08 was one of the worst months in history. The results of September alone are enough to shake even the most confident investor. Amazingly, domestic markets looked downright positive compared to international markets. Even fixed income wasn’t the safe haven it typically represents. Suffice it to say; when you receive your September statements it will not be pretty. You have been forewarned.
Believe me when I say "I feel your pain" when we talk about the negative performance of your accounts. Not only do I see it in your personal accounts, but also in the sum of the accounts that I manage for my clients. I’m guessing that one of the many reasons you chose to have me help you is that you knew that I would care about you. I do. I care deeply for the well being of my clients and thus this has been a very challenging time for me as well. Just ask my wife!
I have fielded multiple phone calls from clients (and a few from non-clients who value my perspective on things) suggesting they want to end the pain and go to cash. As an advisor, I can only offer you tips and suggestions on how to handle things. Ultimately, it’s your money and you need to do what’s right for you. Allow me to summarize the most common concerns:
- This time it’s different: It always feels that way while it’s happening. Remember the last market shock, 9/11? Our world had been rocked. Yet 5 years after, the average annual return for someone who invested only in the S&P500 was 8.3% per year. Markets recover from crisis.
- The US has lost its way: Perhaps. But Coca-Cola will still be making soda tomorrow and General Electric will still be making turbines. Farmers will be harvesting their fields and parents will be taking their kids to school. I don’t feel despondent about this country. It is sick, it will be healed. It’s happened to us before.
- The market is down and won’t go again up for years. I doubt this sincerely. The market decline we’ve experienced in 2008 has been driven by a) a mortgage/housing crisis, b) a credit crisis, and c) now, a recession. Each of these take time to mend, but the healing is underway. This too shall pass.
Friday, the President signed the Emergency Economic Stabilization Act, an historic bill that will, over time, ease the liquidity crisis that has gripped our economy for the past few months. But the market didn’t go up as a response. Why? I don’t have a definitive answer, but I will say there is one phenomenon that is continuing that probably (and largely) is making the market stay down: redemption of assets. Let me explain.
If you own a mutual fund, and decide to go to cash, the mutual fund manager can either give you cash from their reserves or, if they don’t have the reserves, sell assets in the fund in order to raise the cash. If this is done on a large enough scale, stock prices have to fall as millions of liquidation orders are processed. How many people have "gone to cash" in their 401(k)s do you suppose? Secondly, and much more importantly, this same process is happening in hedge funds. Many hedge funds have a hurdle that mutual funds do not: many have promised a certain rate of return. If they can’t provide it, they refund as much money as they can to their large investors. A hedge fund will use borrowing ("leverage") in their efforts to attain rates of return. But in a bear market, this leverage has an enhanced destabling effect forcing the manager to liquidate under very unfavorable conditions. Since hedge funds control trillions of dollars in investments, as they unwind to give investors back some of their money, the market is pressured to stay down. Too many sellers, not enough buyers.
Lastly, we are in a recession. Sure the government hasn’t officially called it, but they will. Economic recessions don’t typically last too long and this one might last a bit longer than average given all the other stresses we’re in. But stock markets are leading indicators. It is likely that the market will go up (or begin to go up) before the recession is over.
Back to you. If you have money that you need to spend in under a year’s time (heck, let’s call it two years) then it should not be in the stock market, the bond market, or the futures market. It should be in cash. Period. That is a claim I have always maintained. About 90% of the money I manage is in IRAs or in investment accounts where the purpose is to grow the money over time. If you are planning on spending the value of your account in a lump sum, you need to go to cash. If you are planning to spend it over years and years, then the agreed upon investment strategy of dollar cost averaging, asset allocation, and rebalancing, combined with a sensible withdrawal plan will work for you and your family. It may not feel that way today. Markets recover from crisis.
The trouble with going to cash are many. For starters, you are making a decision based on a pit in your stomach. In other words, you’re making an emotional decision. Nothing inherently wrong with that except the other side of that decision: when do you get back in? If you made a decision to get out because the world was bleak and the markets in the tank (by definition, selling low), you will only re-invest when you’ve removed those concerns. The proof will be when the markets have recovered and you now have emotional comfort. Only then, you will still be at the valuation levels last seen "at the bottom." You will have forfeited your opportunity for recovery, or at best, severely lengthening the time to recovery.
I heard a quote the other day from one of my company’s executives that is worth repeating: "Bear markets don’t end in hope. They end in despair." When it feels absolutely miserable, that’s "at or near" the bottom. Perhaps that’s why some of my clients have begun a slow process of putting more money to work. They see this as a buying opportunity. To each their own.
My final comment. This is probably the ugliest it will ever be for the rest of our lives. There is a confluence of news and events and politics that simply is not normal. And it is likely that once this period is behind us, we’ll be set up for a long period of prosperity.
This too, will pass.