Thinking ahead to your next move

From time to time, a piece of economic news will surface that leads people to question whether it is really a good time to be invested. The announcement of round 3 of quantitative easing (QE3) was one such news item that worried some of our clients (interestingly enough it added optimism to others), and it provided us at Merriman with a great opportunity to reiterate why we think making large changes to your investment portfolio based on economic news is a bad idea.

The evidence is overwhelming that markets are not predictable. If you had asked me for a reason to stay in the market in, say, 1999 or 2007 when economies looked extremely healthy, I could have given you a long list of reasons. But what followed each of those years was a sustained drop in stock prices. On the other hand, if you posed the same question in 2002 or at the end of 2008, there was hardly any good economic news to point to. And what followed? An incredible market rally that recouped market losses much faster than anyone expected. Selling and buying based on our read of the news has a high risk of whipsawing us in and out at the worst possible times.

There are always a host of positives and negatives weighing on the markets. It’s important to remember that economic news, and everyone’s expectations of its impact, is already factored into current market prices. We believe the academics’ argument that the sum of everyone’s expectations is far more accurate than the predictions of any one “guru.”

The risks of high levels of debt, uncertainty around upcoming tax changes (known as the “fiscal cliff”), and continued weakness in Europe may drive prices lower. While current trends, including a dramatically improving housing market and declining unemployment, may drive prices higher. We believe the best way to capture growth over time is to stay invested in a portfolio designed to satiate your appetite for growth while staying within your tolerance for risk, and rebalancing when your portfolio’s mix has materially changed.

If you feel like the risks have become overwhelming, there are some additional things you should consider before deciding to throw in the towel. You need to think ahead to your next move. What will you do after going to cash?

There is risk in not being invested in the markets: First and foremost, cash provides no defense against inflation. Your money may need to be defended against inflation for a long time, and cash does not provide a good defense. Beating inflation is one of the main reasons we advise people to stay invested through retirement.

If markets drop, when will you get back in? Each of the last two market rallies began well before any good news was to be found. Waiting for good news meant missing the bulk of the market gains. On the other hand, if there is a continued market rally after you sell – if markets grow faster than you expect – what will you do then? My experience is that it is very difficult for investors to get back in the market at higher prices; there tends to be a very real fear that the next challenge will cause a decline after having just missed an unexpected rise in values. We have found that over time, disciplined rebalancing has been a better way to buy lower and sell higher than “timing” based on your expectations of the future.

Our strategy is based on the academic philosophy that the future is unpredictable and our clients need to be able to stay the course through unexpected events and drops in the market in order to reap the benefits this strategy has to offer.

Simply being invested is not good enough; you have to be invested the right way. We feel that massive diversification with exposure to large and small companies in both U.S. and international markets, with a healthy allocation to bonds, is the best defense against a range of risks affecting your retirement portfolio.

If you’re ever feeling doubts about your investment strategy, I highly recommend speaking to your financial advisor right away. Rather than moving to cash, it may simply be time to re-evaluate your appetite for risk and returns. An adjustment to the percentage of your portfolio allocated to bonds may be enough to ease your mind.

In the meantime, here are some additional online resources you might find encouraging:

Young Americans: The Death of Equities May be Exaggerated

Liz Ann Sounders, Chief Investment Strategist at Charles Schwab published a piece in August that presents both the challenges facing the economy and the positive forces that are at play.

Equities critical for investment returns, despite volatility

This piece from Marlena Lee’s presentation at the Institute of Advanced Financial Planners Annual Symposium in Vancouver presents research showing that even as the market continues to be volatile, history shows that equities are the best way for clients to earn the returns necessary to meet their goals.