Friday, August 5, 2011

Smart Moves vs. Stupid Moves

By Bert Whitehead, M.B.A., J.D.

Financial chaos is so annoying. We are going along, wary but hopeful, and suddenly everything in the financial arena comes crashing down. The stock market drops 500+ points, the Euro tumbles, oil gets hit hard, and even gold is dropping. What are you going to do?

What Smart People are Doing: Really smart people aren’t doing anything right now; their portfolios are already prepared for this possibility. This may be hard to believe, but the only investment going up is U.S. Treasuries! Smart people (who of course include all of our ‘compliant clients’) have solid bond ladders, particularly if they are retired. This is the bedrock of safety which is the result of long-term, patient financial planning. If we slide into long-term deflation, this is your only safe haven.

Smart people are also dollar-cost-averaging into the stock market. Especially for younger people, this is the time to be buying stocks on a regular basis – not trying to time the ups and the downs. Looking back 20 years from now, it will be clear that this was your opportunity to be building an enjoyable retirement. For retired people it is important to keep a balance between bonds and stocks so that your bond ladder can be replenished when the economy comes up for air. Stocks are your assurance of long-term prosperity. Over time the stock market will continue to go up as long as we can maintain our productive and innovative heritage to compete in world markets.

Smiling people have a healthy mortgage on their house, on which they can comfortably make their regular payments. If there is enough equity, it is time to check on refinancing since mortgage rates are falling. When you refinance, you essentially cut your cost of living. Now is not the time to pull more money out, or pay off part of your mortgage if your appraisal comes in too low.

Stupid Moves People Do: Selling all your stocks in a panic, or because you think you can time the market. If you have already done this, now you have to decide when to buy back into the market – so you will have had to make two decisions right to come out ahead! The result usually is that market-timers become obsessed with the market which is a waste of time and produces needless anxiety for no long-term gain.

People who don’t have enough liquidity (i.e. cash) can easily be wiped out if hit with personal setbacks (illness, lay-off, etc.). It is also dysfunctional to hold on to too much cash, frozen by fear of loss if it is invested. You’re not making any progress if you have been sitting on excess cash earning 0.25% for the last couple of years. You would be much better off having bought long-term Treasury bonds 2-3 years ago with a fixed rate of 3.5%-4.0%. Even though those rates seemed ridiculously low then, you would have been much better off now, and this condition may well continue for a few years.

Having a home all paid off is psychologically appealing to people, especially when times get bad. It is counter-intuitive, but it is imperative now to protect yourself against future inflation which eventually will come roaring back! A 30 year fixed rate mortgage is your best protection against inflation. It will also give you additional cash for liquidity, to build your bond ladder, and to start or increase dollar-cost-averaging into today’s market, where all the stocks are on sale!

ACTION ITEMS: Contact your ACA fee-only financial advisor to:
• Make sure you have adequate liquidity
• Start/increase your bond ladder
• Start/increase dollar cost averaging into the stock market
• Get a mortgage on your home (yes, the interest can be deductible if you use it for investments!) or check into refinancing.

In my last blog, I correctly noted that the debt-ceiling fiasco panic would likely be the Y2K non-event panic of this decade. The outcome of this controversy, however, highlighted the severe problems in our national economy. We seem to be sucked into a vortex of malaise, as Jimmy Carter called it, with employment and housing stuck in a inexorable downslide. The government’s application of Keynesian tactics has reached the point of miniscule marginal utility.

This financial reaction is reflective of a genuine concern on Wall Street about the increase in overspending in the past couple of years. The federal government is borrowing 40 cents of every $1.00 it spends. The economic collapse and impending defaults in many over-spending European countries may foreshadow our own fate. It is politically debatable as to the cause of the widespread lack of confidence, and economic imbalances have a way of being self-correcting in the long run, but the US probably deserves to have it’s credit rating downgraded.

The lesson to be learned here is our own challenge. We can’t do anything about the national economy; it is our job to get our own house in order. Households cannot spend more than they earn. Your future depends on your saving 10% of your income and keeping a balanced and diversified portfolio, not on whatever the economic commentators argue about.

I am convinced that the contribution of professional financial advisors to our clients lies not in feverishly buying and selling securities, but helping clients do smart things in their own lives, and helping them avoid doing stupid things.

I appreciate the editorial review contributed by Chip Simon, CFP®, an ACA colleague in Poughkeepsie, NY and my partner Pamela Landy, M.B.A., J.D., C.F.P.