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« Merry Christmas to us All! | Main | Financial Independence »
Friday
Nov222013

Can You Take a Punch?

Mike Tyson, the former world heavyweight boxing champion, is not well known for making profound observations, but I believe he made at least one.  Once prior to a fight, a sports reporter asked him how he planned to handle his opponent who had said that he had a special plan to defeat “Iron Mike.”  His response was that, “Everyone has a plan until he is hit in the mouth!”  Mike may not have realized it at the time, but his observation has meaning far beyond the boxing ring. 

There is more than one way to be a successful investor in the equity markets, but the one thing that most successful investors have in common is that they have a plan.   Warren Buffett, who has enjoyed a modicum of success, buys businesses that he believes are undervalued and then holds them for the long term.  I am told that there are successful day traders (though I do not know any of them,) and I suspect that they have plans that they follow to time their trades.  Others who invest in individual stocks have buy and sell rules based on price earnings ratios, dividend growth rate, the markets 200 day moving average, or other criteria that they follow.  Still others have realized success using stock and/or bond mutual funds.  It seems that those who enjoy the most success are the ones who most closely follow their pre-established plan.

The investment policy that I try to follow, and suggest for my clients, is to allocate one’s investment money between equities (stocks or stock funds) and bonds and cash in a fashion that meets their individual needs.  For example, a retired couple might have 40% of their portfolio in equities and the rest in bonds and cash equivalents.  They should think of their equity portion as their growth engine for the long term.  This represents money they will not need for at least five years.  The bonds and cash portion of the portfolio serves to smooth out the inevitable swings in the equity markets, hopefully provide a bit of growth, and to be a source of cash in times when the equity markets have swooned.  As the various asset classes move up or down in value, these positions would be periodically rebalanced by moving money from one position to the other to keep the initial allocation plan in place.

Of course how much you may allocate to each portion depends on your particular circumstances.  You have to consider your age, your future goals and financial needs, and your tolerance for risk.  This decision is very personal and will vary from person to person.  But once your allocation decision is made, I suggest you stick with it through the market’s ups and downs.  Following such a plan accomplishes at least two important things for the investor: 1) It forces one to buy low and sell high as the rebalancing process will dictate that gains are taken from positions that have grown to be too large and invested in the positions that are smaller than the original allocation called for; and 2) It takes emotion out of the decision. 

Perhaps the most important thing an investment policy, can do for us is to help us control our emotions.  Many studies (Google it) have shown that emotions will often lead us to make exactly the wrong investing decision.  Rational investing decisions are best made with CNBC turned off, all of the “talking heads” tuned out, and our long range plans in mind.  This is easy to say, and very hard to do because we are emotional animals.  It is difficult to avoid the herd mentality as they all rush for the doors screaming about the sky falling and the end being near!  Remember the market panic of late ’08 and early ’09.  It seems no one likes equities when they are discounted and put “on sale,” but that is when they will be purchased by those who are rationally rebalancing their portfolios and following their plan.

Perhaps some of you were tempted to make some changes recently in response to the squabble in Congress over the debt ceiling issue.  My question would have been, “Is this an emotional or rational decision, and will these moves comply with your investment policy?”  It is very difficult to make rational investment moves in response to governmental squabbles.

One of the roles I try to fill for my clients is that of an emotional anchor; I try to keep them from getting too high when the markets are going up as they have recently, or too low when markets turn down.  Every asset class has its day, and all of them will eventually go both up, and down, in value.  That is why I suggest a balanced portfolio where our money is spread over a variety of asset classes.  That is also why I suggest we establish a plan, or a policy that helps us decide when it is time to make changes to that portfolio.

So this is where Mike Tyson’s observation may apply to us.  We need to ask ourselves if our plan is good enough to withstand a stiff punch to the mouth by Mr. Market; better yet, are we committed enough to stick with our plan after such a lick?  A good plan will help you take such a lick and remain disciplined.  You will very likely be rewarded for such a response as history has shown that the disciplined investor is more likely to succeed over the long term.  But through it all remember: money is not the most important thing, not even in the top ten; but still, money matters.

Fly/Drive Safely

22 November 2013

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