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Looking Backwards at the Dots…

Steve Jobs once said, “One can only connect the dots looking back, not forward”.  I have found that such wisdom is usually better understood by those with more to look back upon and less to look forward toward.  As of 10:30 am the day of this writing, the 9th of November 2011, the markets are down about 2% due to the European debt crisis – or so they say – which was a “dot” I never would have foreseen, when I began my career.  Recently, the European debt crisis has been the story.  Tomorrow, we may have another story, another “dot” in our inventory of “dots”.  In times like these, it is good to provide a refresher on investment principles – the lenses we should look through when viewing our investments.

Only a few days ago, I read an article in the T. Rowe Price Report written by Ned Notzon, a retiring senior asset allocation strategist, where he passes along the lessons he has learned from his career in asset allocation.  Since I agree with him and, with the above attribution, I will summarize his thoughts below.

  • Individuals have to stop being passive about their finances.  The decisions they have to make are numerous and the responsibility for our financial success increasingly rests on their shoulders.  Each of us must take responsibility for our financial futures, if there is to be hope for the financial futures of our larger economies and for those who follow.
  • People are living much longer than they expected.  This trend is projected to continue.  The ravages of inflation, even a low rate of 2%, will destroy a retirement lifestyle if assets, such as equities, are not a part of individuals’ portfolios.   (At 2% inflation and a 30 year retirement, the last year of retirement will see average prices being 81% greater than in the first year of retirement.)
  • Even in the face of inflation, bonds still play a major role in a portfolio.  They diversify risk exposure and reduce the losses when equities “turn south”.  Not having to panic during the inevitable market cycles is a key to controlling the behavioral side of finance.
  • Speaking of behavior, some investors are reluctant to embrace any market risk, the risk where most securities move in cycles.  Yet, to gain wealth and to increase one’s purchasing power, one must take advantage of higher expected return assets (i.e., riskier assets).  On the other hand, some investors are very willing to embrace market risk and some do it at precisely the WRONG time!  They buy late, after gaining “certain” confidence in the market’s upward trend, and sell when they can’t stand the sick feeling in their stomach any longer.  Selling low and buying high is a sure way to not gain the advantages of equities.  Many years ago, the editor of Money magazine said, “Timing is everything, but impossible.”  Thus a person needs a sound investment plan that continually is rebalanced (i.e., diversified) over a long period of time, while being disciplined to continue to save more.  These actions will make sure that a plan remains true to course.  In fact, rebalancing is a gentle, disciplined way to assure that you sell portions of your portfolio when they are relatively high priced and buy more of others when they are low priced.  Research continues to point to the importance of saving money, being diversified, and having a long-run, disciplined commitment to financial success.
  • Add some inflation hedges to your portfolio; like real estate, commodities, and precious metals.  These can reduce volatility and provide exposure to different market cycles.  Yes, some have not been in favor recently (e.g., real estate) but diversification is a key to long-run performance.
  • Have some money invested in countries outside the United States.  Sure, there is some risk involved, which is why you want to invest in overseas securities.  Risk works to enhance positive returns, as well as negative returns.  Importantly, the United States is an increasingly smaller portion of the world’s economy, as a result of much of the world’s growth occurring overseas.  To protect your family’s financial future, make sure you have exposure to these growing markets in order to provide the necessary diversification, unavailable through single-country investing.

Most of the above is not new information.  It might, however, be new to you as far as your decisions are concerned. We all wish for a world where there is no poverty and upward mobility is the outcome of hard work and good personal decisions.  Certainly, there exist public policies that could be changed to improve economic mobility.  I, also, have no doubt that there are millions of private decisions that could be changed to help enhance the chance for financial success and independence.