The Cost of Getting Even

It’s more and more commonplace to have a discussion with someone who must come to grips with what Dennis Gartman calls the “viciousness of percentages.” This is simply the average one needs to obtain to regain from a loss, “the cost of getting even.” Remember, a loss of -25% one year and a gain of +25% the next year does not get you back to even. Instead, this leaves someone a good bit behind “par” and the greater the loss, the greater the required return on capital to get back to even. Therefore, find below a chart that illustrates the average gains necessary to regain from a loss:

In summary, the lesson here is really quite simple: keep your losses to a minimum. In other words, what is your risk tolerance level and how long do you have to invest? Make sure these match up accordingly and don’t put too much at risk without the proper amount of time necessary to ride out short-term volatility in the market.

A Crash Overhang

One of the unfortunate hangovers from the 2008–‘09 market crash has been some investors continuing to try to “time” the market with their mutual funds. We continue to hear that small retail investors, and usually those without an investment advisor, have not completely returned to the stock market. Whether this is with their 401(k) plan or other investment portfolios, some investors have missed much of the recent recovery employing some unproven strategies.

Frankly I can understand their concerns and fears and their desire to be out when the next crash happens. The problem is there’s usually no one who knows exactly when the next correction will happen. Consider this… since March ’09 the stock market has grown back in spite of all the negatives we hear in the news today, while many have warned another correction is coming. Sometimes in the industry we hear this referred to as, “the market climbing a wall of worry.”

Remember that a strategy of “market timing” almost never works to improve one’s overall return when considering a full market cycle (from the peak, to the valley, and back to the peak again), particularly with mutual funds. This can be validated by third-party research and is why you hear most Investment Advisors discourage market timing. However, I must say moving out of the market can be an effective means of reducing fear.

I have found some of the confusion comes for personal investors as they have heard and read investment language (reduce stock exposure, increase cash position, expect a market pullback, stop-loss, limit order, etc.) that typically can be effective when trading individual stocks. Don’t confuse this with investing in mutual funds. According to Vanguard, mutual fund investing provides greater diversification as, “a single mutual fund most likely holds more securities than you could ever buy on your own. An advisor handles the fund’s investment management responsibilities, taking the burden off of you.” Therefore, remember that an actively managed fund manages within its prospectus objective in light of what is happening in the economy.

Also given the logic that investing in individual stocks can be significantly more risky than investing in stock mutual funds, it’s logical to conclude that you can also lose more in individual stocks. This contributes to why we saw many individual stocks decline much greater than stock mutual funds over the recent 2008-’09 market correction. Consider as Investorguide.com explains, “Earning a high level of return requires taking more risk, but taking more risk does not always equate to a higher return. No matter what you invest in there is an inherent level of risk associated with all investments.”

So in the end, unless there becomes a serious market correction, which doesn’t happen very often, mutual funds may not offer enough volatility to pay off using common timing strategies. In other words, mathematically it’s very difficult to make it work. As we have learned in the last correction, a market correction is not a clear signal that another major correction is around the corner.

In summary, there are some strategies that can help worried investors that are concerned of market risks. But quite frankly, and contrary to what you may hear, market timing usually does not improve the overall long-term return. And if you feel advisors are not forth coming about timing, ask your investment advisor if he “times” his or her mutual funds.

Re-Building Retirement Wealth, Part 4

Most have heard the phrase “don’t put all your eggs in one basket,” and pretty well understand the wisdom within this statement. But have you taken this a step further and applied it to diversifying your retirement income? We have seen many times that diversification among retirement income planning has been overlooked. And this can be a critical need for a retiree… so consider what some of the sources of retirement income you have in place. Perhaps you can identify with one or more of the following basic sources of retirement income:

Investment portfolio or savings – Income is generated from one’s investment portfolio, which is solely dependent on the stock and bond markets, such as a 401(k) plan, IRA or other accounts which may include mutual funds, individual securities, etc.

Employer benefits – Some still have an employer benefit (such as the Federal or State government, a large corporation, etc.) such as a Defined Benefit retirement plan which will send monthly checks after you retire.

Annuities – Another effective strategy can be variable annuities that offer lifetime benefits without annuitizing (via a Guaranteed Income Rider), which ultimately pays the policy annuitant a monthly income benefit for life, and the beneficiary receives the balance at death.

Rental and/or income property – Working assets that generate a constant flow of income, such as real estate, a trust or other account or inheritance property.

Notes Receivable – Can include private notes that others owe you or even arrangements with another party that can provide a set monthly income.

Timber proceeds – In the case of land ownership, periodically a timber cut or thinning can provided additional cash flow.

Oil/Gas partnerships – Can provide periodic income to the limited partner who assumes no liability beyond the funds they contribute to purchase units in the partnership.
During retirement the best of both worlds is at least stable income, but with some potential to increase over time. It is quite possible diversifying your retirement income may help produce that outcome.