Letter to Our Clients - August 2009

August 2009

 

Dear Clients and Friends:

THE WORLD DID NOT END!

From September 2008 to April or May of 2009, it seemed clear that life as we had known it was ending. TV, radio and print media were predicting the Dow Jones Industrial Average would drop to 5000 or lower, there would be world-wide deflation and protectionism, our banking system and Wall Street would soon collapse, and a barter economy would play a huge role in our daily commerce. There was no good news to be found about employment, bankruptcies, productivity, corporate profits, or tax revenues for state and local governments.

And yet, from March 9, 2009 to July 31, 2009, the Dow increased by approximately 40%. How did that happen? More importantly, where will it go from here?

I have no way to predict where the markets will be at any given point in the future. As to why the stock and bond markets recovered so dramatically, that would be a better subject for a book rather than a two-page letter.

What I do want to share is some of the debate that has occurred in the financial services industry, especially around March and April of this year.

Many clients were saying “I can’t afford to lose any more.” Likewise, most financial advisors and stockbrokers were angry. They were angry that the underlying assumptions in which we had been trained, and under which we advised clients and managed money, no longer seemed to work. The two major assumptions were that asset allocation and diversification would limit losses, and that “buy-and-hold” was the most prudent long-term strategy.

If investing, or life in general, was a race or a game with a definite ending point, the concerns might be legitimate. But life did not end March 9, 2009. The game was not over, and it is not over now. Logically, asset allocation still makes sense, and I will continue to stress its importance to you.

As for “buy-and-hold,” I never did believe in it. What I do believe in is “buy-and-manage.”

Congratulations to all of you who stayed with your investment strategy through this downturn. Most of you are now down “only” 10% to 15% from September 18, 2008, the day Lehman Brothers failed and the crisis began. During this time any buying or selling we did was with a mind to improve the individual holdings in your accounts, rather than radically changing the investment strategy. During this time we operated under the “buy-and-manage” philosophy, and I think it has been successful. I hope you think so also.

We are near or at a point where, if you want to become more conservative, I would like to help you accomplish that. However, I am not getting those calls. Instead, many people are saying they believe the markets look attractive, and they would like to increase their stock market participation. However, before we help any investor take a more aggressive approach, we will ask you to remember March, 2009. How would you feel, and what would you do, if we suddenly found ourselves in that situation again?

Regarding the economy overall, what we are reading is that Americans have gone from a negative savings rate to a positive rate of 5% or better. Many believe it will go higher from here as we enter a new age of frugality. In many ways this would seem to be obviously good news. Businesses and individuals go into bankruptcy because they spend or borrow more than they can repay, especially if their income drops or does not go up as much as projected. Analysts like companies that have low debts levels, positive cash flow, good cash reserves and predictable sources of income. We hope all of our clients treat their financial lives as a business, and operate according to similar models.

However, consumer spending for years has accounted for 70% of our country’s economy. If everyone saves more, it means we spend less on a national level. If we spend less, the economy will not recover the same way it has in the past. If this is true, we might end up with single-digit annualized returns for the next 5 or 10 years. On the other hand, it seems that the majority of people in the financial services industry are bullish that the stock market has fuel (available cash and corporate profits) and momentum to generate double-digit returns for the next few years.

And yet … the world is terribly unpredictable. In October, 1987, the stock market dropped about 22% -- in one day! That would be equivalent to almost a 2000 point drop in the Dow – in one day. 9/11/01 and the consequences of the Lehman Brothers failure are two other examples of things that seemed so outside the realm of possibility that they did not need to be factored into an investment strategy. Instead, we think our investment plans and our expectations need to include the possibilities that these kinds of events will happen again. When that happens, and I believe such events will happen, hopefully we can act according to a plan, and not make major decisions as a reaction to the situation at the time.

So, here are my recommendations.

1. If you think you want to change your investment strategy, to be more or less aggressive, let us work together to have a plan that gives us guidance about when we should pull back from this new plan, and what our next one or two fallback strategies might be.

2. Work to build up significant assets in non-IRA, non-401(k) type of accounts. You lose a lot of control over your taxes and ultimately your spending if you retire and have most of your money in accounts where the dollars are fully taxable as they are withdrawn. In fact, I urge you to view your IRA’s as a replacement for salary, and to use non-IRA accounts for vacations, home repairs, and other non-recurring expenses.

3. If you are contributing to retirements plans, such as IRA’s and 401(k)’s, be certain it is in your best interest to save on taxes now and pay it later. If you are in the 15% federal tax bracket, this may not be the case. Also, do not forget # 2 above.

4. If you are investing monthly, whether into a retirement plan or just an after-tax account, it might make the most sense to be relatively aggressive with the dollars you add on a monthly basis, but manage your investment principal so that it is perhaps less subject to market fluctuation.

5. Remember, the past is a guide to the future. It is not a predictor.

As always, thanks for the opportunity to work with you. Please call whenever we can be of assistance.

Best Wishes,

Robert K. Haley, JD, CFP®, AIF®