By all accounts, the economy is recovering. Sure, there are naysayers harping on doomsday sensationalism, but the fact of the matter is unemployment hit a five-year low in January, rates remain relatively low on borrowing, there has been positive movement in the markets and new sectors are opening up. Yet, those in the know are investing in patience and prudence rather than quick fixes and the mythology of “hot picks” that has lost many a man his shirt (or worse) in recent history.
This may not be new so much as it is new again. Success is usually driven by fundamentals rather than emotions, whether we’re talking about finance or sports or anything else. A quick, flashy burst may infuse a portfolio with a little extra cash, but ultimately it is those who take the long view who tend to fare better in the end. Of course, after a few years of malaise and stagnated growth, if not outright loss, we want results. And, as good, competitive, anxious Americans, we want them now. While some may have seen an uptick in their personal wealth in 2013, most are hungry for the pre-2008 level of earnings. To avoid chasing butterflies, seasoned advisors are advocating an investment in attitudes as the shortest distance to success.
How Soon is Now?
The big question weighing on many minds is “when will my investment yield serious returns?” as opposed to “what is the best route to returns?” Rather than suffer the slings of a stormy market, analysts are pointing to long-term strategies as being the path of most resilience.
Robert Rosenthal, chairman of Jericho-based wealth management firm First Long Island Investors, considers long term as three to five years or even longer. He believes healthy skepticism is constructive; it’s evaluating things on a daily basis or buying into euphoria that can be counterproductive. In his 30 years in business, he’s seen his share of ups and downs. “Every time there’s been a crash (’97, ’98, 2000, ’01, ’08)… if you didn’t panic and you held on, for a year or two years, three years, you did very well. So the moral of the story is don’t panic.”
James Costello, senior vice president in Morgan Stanley’s Garden City office, takes it a step further. “There is a significant difference between long-term investors, traders and income investors,” he said. “Long-term investors have three, five- or ten-year time horizons, traders have one day to six month time horizons, while income investors generally concentrate on current income or current yield.”
For some, the challenge is balancing daily lifestyles with long-term goals. Trends sweep through our lives in a matter of days—immediacy of communications and mobility engender us with the feeling that we live an eternity in an afternoon. That sense of constant urgency can lead to hasty actions, which ultimately create a ping-pong effect on our financial statements. Wealth manager Donald E. Lippencott, of Lippencott Financial Group in East Setauket, reinforces the need for a delicate balance. His firm focuses on wealth and asset protection, estate and legacy planning and business succession. “We are always reassessing the client’s goals and long-term needs and objectives,” he said. “If the goals have not changed, it’s generally not necessary to change the strategy.”
It’s this last part that is usually the hardest to accept. Parents don’t want to deny their children a dream wedding or Ivy League education and spouses don’t want to curtail their companions’ lifestyles. A breeding ground for conflicting interests arises and often, snap decisions are made because focus is on the immediate, rather than the big picture.
Rosenthal said “the stock market is a voting mechanism—it’s what people feel a company is worth on a given day without necessarily looking at the fundamentals supporting the company.” He said “mutual funds tend to do much better than the investors of mutual funds” because the anxiety created by headlines can trigger people to pull their money out of an investment too soon. Meanwhile the sale of that stock has nothing to do with the company, which can be performing quite well. Part of this has to do with fear—the pain of a small loss generally being greater than the joy of a small gain. But “the key to wealth creation is compounding over a long period of time,” Rosenthal said.
What’s your poison?
In the 1970s and 80s, E. F. Hutton & Co established itself as one of the most respected brokerage houses in the US. Whatever the firm’s overriding strategies may have been, the business was built around the idea that their stock picks were so consistently good, “When E.F. Hutton talks, people listen.” We’ve seen other such “consistent” achievers since then, Bernard Madoff among them. And despite both of these performers going down in flames, the fact that they achieved such acclaim points to an inherent human tendency to believe in miracles.
In the investment sphere, the stock market draws in the largest number of people, most of whom hope to dodge the odds over the short term, but that’s not the only option. “Many people refer to ‘the markets’ referring to the stock market,” Costello said. “There are other segments to the markets—i.e. taxable bonds, tax-free bonds and CDs or money markets. In most cases, the stock market is more volatile than the other markets but over time the stock market produces the highest returns.”
Tempting as those “highest returns” may be, the risk may not be something every investor can stand—emotionally or financially. As important as it is to focus on goals, the current picture plays a big part. Tax-deductible pensions (like 401k plans) are ideal for median income families, according to Costello. But affluent investors are better off amassing tax-free bonds as significant components of their portfolios. Those with more than several million in investible assets should strive for balance among various asset classes to foster greater diversifi cation and minimize risk.
George Diffendale, a partner in Lippencott Financial, provides retirement and estate planning as well as asset conservation. He also includes bonds among the eggs in his clients’ baskets. “Clients who have an income need often rely on the dividend payments of bonds. If your objective is income, and you have no need for instant liquidity, there is nothing wrong with a well diversifi ed bond portfolio.” Diff endale equates the practice to owning an apartment complex. Landlords collect rent from tenants and pay expenses on the building. The value of the building may fluctuate, as might the relative expenses, changing the net income from the collected rent, but the intent is to produce a profi t. Similarly, “…that’s what a bond portfolio is like. You collect checks. The value of the underlying assets change from time to time or day to day, but you own them for the paycheck.”
Rosenthal includes bonds in most clients’ asset allocation, however he sees that as an area likely to slow in performance, indicating investors holding short-term fi xed income and cash could see returns less than the rate of inflation. He favors a one-two punch of conservative asset allocation and other defensive strategies that should earn more than bonds. One new strategy he is making available to some clients is participation in a hedged “fund-of-funds,” a concept that operates with some strategies outside of the stock market, including the purchase of distressed debt and event driven opportunities.
Where do we go from Here?
Interest rates have been kept artificially low in recent years, but over time they will trend up (there’s nowhere else to go). Lately, investors’ impressions of the financial systems have been improving, too. And with that, their appetites.
Nevertheless, daily headlines being riddled with unrest over Obamacare, the debt ceiling, war and complicated regulations are causing bumps in the road. This may compound what Rosenthal called “the wall of worry,” things that can adversely aff ect investors’ activities, but he also said the wall of worry isn’t new and shouldn’t rule individual motivations— you can’t control the market influences, just yourself. He cited the midterm elections as an example of an event that could have a “potentially disrupting influence” in the short-term because of the particularly acrimonious political tenor. But in his approach “not just the assets are diversified, the strategies are diversified.”
During the second half of 2013, there was a healthy choir singing Europe’s praises—many claiming the Eurozone’s recession was nearly at an end. That’s good news in an actionable way, because investors could allocate funds to European stocks (though by now many may be overpriced), but there’s also an intangible component: As a high tide raises all ships, it can get mighty crowded on the seas. Quickly. A fourth quarter white paper issued by Charles Schwab pointed to an industrial renaissance happening in the US, coupled with the exploration of alternative energies that are increasing the number of jobs, as not only positive stimulation in the economy, but possibilities for new investment categories.
Exploring new frontiers, whether in sectors or geographically, can be beneficial to developing a broader, more flexible attitude as well as seizing previously untapped opportunities. Middle Eastern banks have been lauded as landing spots, as are countries where populations skew younger because the constituents are motivating sectors like real estate, infrastructure and consumer electronics.
Lippencott takes it back to the five- to seven-year plan. “Clients with long-term outlooks typically have the time for markets to recover, and generally will be better served to stay within the strategy that fits their objective. By the time most think it’s time to get out, its too late.”
New Attitude, Same as the Old Attitude
Even though the markets can be fickle friends, they did outpace earnings growth last year. There are storied blue chip darlings that tend to be dominant performers in their sectors (Google, Coca-Cola, Procter & Gamble), but those responsible for clients’ personal economies agree it’s better to have a favorite strategy than a favorite company. A company could overleverage itself, be blindsided by a more nimble competitor or render itself obsolete (Grumman, anyone? AOL?).
Rosenthal said the key difference for an investor is making decisions based on the vitality of a company rather than looking at it strictly as a symbol. Costello took it to the recent crisis, “The recent 2007-2009 correction of about 50 percent was caused by the confluence of several factors that feed on each other, i.e. mortgage crisis, housing crisis, Lehmann’s bankruptcy and government takeover of Fannie and Freddie… What many people did was panic. As they saw the equity in their homes and second homes shrink, the banks withdrew credit and many lost jobs…” As a rule of thumb, Costello suggested not investing with funds that might be needed within the next three years so that if they shrink, they may recover before they’re missed.
Lippencott maintained, “Trust and confidence in the markets is very important. Arming oneself with the facts about what is going on versus simply reacting helps to have confidence. The key is to be comfortable with your goals and long-term objectives, and stick to them.”
Still, most laymen can get spooked when they hear things like “slow recovery” or “flat earnings reports.” It gets more difficult to trust the future when the immediate seems contradictory. And it’s easy to internalize the sense of underperforming. Domestically, we have financial insecurity at all levels of government, adding to the gloom and most people are simply fatigued with constantly having to “do more with less.” But in the last five years, the economy has been recovering, albeit slowly, despite many ups and downs—the S&P 500 is up 100 percent. It seems indeed, when it comes to making financial decisions, the key is investing in steadfastness.
Money Talk
A few buzzwords are trumping even celebrity gossip in the headlines these days. For the most part, these are the vernacular of the moneymen, and we pay them to worry about it. But a brief familiarity will certainly keep your advisor on his toes during the next consultation.
Durable competitive advantage: Companies have this when they are rooted in best practices that keep their profits steady and ahead of the competition. They tend to have brands that convey a promise of quality and they have reputations for running lean and mean to keep costs down. Some even have a stronghold, monopoly-like status in their footprint, like a utility company.
Fed tapering: Related to quantitativeeasing (page 170), this has to do with the Fed reducing the amount of bonds it’s been buying to keep the economy afloat (from $85 to $65 billion). According to Don Lippencott, “So far, the taper has not really hurt. It seems the anticipation of the taper has been worse than the actual event.”
Impact investing: Aligning personal values with financial choices. Example: An investor who values green energy would avoid putting money into companies engaged in controversial fracking, but skew investments towards solar shingles instead.
Quantitative easing (QE): Rosenthal explained this as, “The fed’s purchase of long-term securities by expanding the fed’s balance sheet” which did some good, and put money into the system, but hurt some consumers because they were receiving an inferior rate of return on their savings.
Volcker: A piece of legislation deriving from Dodd-Frank, Volcker seeks to scrutinize the motivations behind a transaction. The idea is to eliminate traders who make a buy/sell decision based on bonus structures or other personal affinities. Volcker has been keeping professionals on their toes so far, but is receiving jeers as being highly abstract and unquantifiable.