Understanding Investing Risks

The last several years has instilled into investors thinking a couple of major fallacies. One is that when the markets start to go down, it is going to go way, way down. The second is that another 2008 is right around the corner, even though it is a once in 43 year occurrence. Both of these assumptions are wrong. You have to understand that we now live in an instantaneous world. News travels exceedingly fast and reacting to it just as fast, is totally foolish. I do not mean to insult anyone, but it is important to say the truth.

Being invested in hedge funds, alternatives, stocks, bonds, commodities, real estate, annuities, CD's and cash has its risks and rewards. Let's look at these choices since they each have pluses and minuses.

Hedge funds - What is a hedge fund anyway? There are about a dozen different mainstream hedging strategies used today. They all have one thing in common. They strive to reduce the risk in a portfolio. Let's drill down further. Suppose you have a portfolio of 30 stocks. Unhedged, you would be subject to the performance of those 30 stocks for as long as you held them. A hedge fund may hold the same 30 stocks, but put a "hedge" on to protect against a sudden downdraft in the stock market. However, by doing so, it's upside performance is sacrificed. For example, if the hedging was done by buying Put Options, then there is a cost to buy those 30 Put Options. If any of those stocks do not go down as hedged against, then the performance of a 30 stock portfolio with Put Options would significantly under perform. A 30 stock portfolio without the hedge would be better in that situation, than a 30 stock portfolio with Put Options as a hedge. Don't you see? So, what we learn is the risk to a hedge fund is when the market goes up.

Alternatives - Alternatives is kind of a broad term these days, but it can include promissory notes, structured products, limited partnerships, Regulation D offerings, private equity, non-publicly traded investments like REIT's and Business Development Corporations (BDC's), currency funds, physical gold, silver, platinum and other investments. The risk to these can range from a lack of liquidity, inaccurate valuations and or pricing, Ponzi scheme potential, lack of dividends, not to mention significantly more risk. These investments are not appropriate for people with less than $1,000,000 net worth or $200,000 per year in Adjusted Gross Income, in my opinion.

Stocks - Stocks on the other hand benefit when the market goes up, but have the risk of a market sell off. This would include stock mutual funds and ETF's, too. Historically, long term investors have always been rewarded for holding onto stocks for five, ten and certainly twenty years or more. The longer the holding period, the less risk there is to stocks.

Bonds - Bonds are touted as a safe investment by many. However, they are subject to interest rate risk. When interest rates go down, bonds benefit. However, when interest rates go up, they can lose money. It depends on the maturity, the issuer, the rating and other factors, but in most cases bonds will always be affected when interest rates rise.

Commodities - Commodities typically benefit from a booming economy. Commodities need inflation to benefit. It is more sensitive to supply and demand issues. Oil is a perfect example right now. When there is less demand, the price falls. Oil was priced around 100 a barrel not very long ago, but now is down around 60% from that. So, if you bought Oil at 100 a barrel, then you could be down 60% roughly. So, your risk with Commodities is lack of demand and over-supply.

Real Estate - Real Estate Agents always like to tout real estate as one of the best places to put your money. It can be a good place to put your money if you use other people's money to do it. There is no doubt that it can be extraordinarily foolish to pay off your house. Read my book, "Meet Wally Street. The ReasonYou're Stupid" for more on this.

Real estate is subject to supply and demand, also. For example, in the 2008 crisis, there was way too much demand coupled with people who bought homes at the top of the market (over-priced.) When things are over-priced, they eventually correct back to a median or more normal supply price. This was very painful for a lot of people in America and some still have not recovered from it. Real estate is also subject to interest rate risk. If you are invested in real estate via a mutual fund or other investment and rates go up, then you are going to be negatively impacted.

Annuities - Annuities are fully guaranteed by the insurance company who issues them. I am talking about Fixed and Indexed Annuities in particular. Variable Annuities have the same risks as Stocks, so I am not discussing them here. I am only discussing Fixed and Indexed Annuities. Fixed Annuities pay a fixed rate of interest. I received an interest rate update from an insurance company today. A 5 year fixed annuity is paying 2.75%. How does that sound to you? Yes it is guaranteed, but will you be satisfied with a 2.75% growth rate for the next five years?

Indexed Annuities pay interest based on several factors, but in a nutshell they are tied to some kind of index and they return a percentage of that index to policyholders each year. So, if the S&P 500 goes up, then you get a percentage of that upside credited to your annuity policy. If the S&P 500 goes down, then you more than likely make a 1% or 0% return. That may not sound all that great, but it is certainly better than losing 10% in the stock market, is it not? The risk to these is that you will have years of 0% or 1% in some years when the stock market is down.

CD's - CD's are fully insured by the FDIC, but today's CD rates are paltry to say the least. A 3 month CD may pay about 0.25% annualized. Not a lot to write home to momma about. The risk to CD's is little or no income and lack of principal growth.

Cash - Cash or money market funds have some risk to them, but it depends on where you have your money market fund. If it is a FDIC insured bank account, then you are safer than with a mutual fund money market. Rates on money markets are about 0.02% right now. The Federal Reserve has basically stolen from average investors in order to allow the major banks to recapitalize after the 2008 Great Recession. Is this fair? Of course not, but what can we do about it? Not a whole lot, unfortunately.

Where do you invest knowing these risks?

There you have it. Those are your major choices. Which of those is the best place to invest? Should you put all your money into one of these? That might be rather foolish.

Instead, perhaps you may want to be in most or all of those areas, because you never know which one is the right place to be from year to year. This is called being diversified.

This is what we do. We don't react to every piece of frightening news on television, nor to the endless stream of pundits and hucksters who preach doom and gloom. If you are smart, then you will quit watching television and let your diversified portfolio go to work for you. Sure, there will be times when markets pull back, but over the long haul you will be rewarded.

1. Have we been rewarded because I made the decision in January of this year to eliminate Emerging Markets from our portfolios? Yes we have, but it might have gone unnoticed.
2. Have we been rewarded for removing High Yield from our portfolios? Yes we have, but again it has probably gone unnoticed.
3. Have we been rewarded for have about 0.52% of our portfolio in China? Yes we have but again it has most likely gone unnoticed.
4. Have we been rewarded for getting out of Gold at $250 an ounce higher than where it is trading today? Yes, but this fact too has probably gone unnoticed.

When you wonder why we haven't done anything in the last week perhaps you might consider my four points above. The fifth point is that we are on top of things even if you do not believe that we are. We will make adjustments when we feel they are warranted. As of today, doing nothing in the last week looks to be a pretty good decision in my book.

Stay focused, stay diversified and stay away from emotional decisions based on the television news. Remember this key point. It never feels good to be invested. Something is always going on to affect one or more of the above investments. Always! You must understand that it never feels good to be invested in any market.

The goal is to have a plan, a process and a professional. I call this the three P's. That is what you have if you are a client of ours and you take our advice! I have trademarked a phrase that is apropos. Keep Your Assets. Take My Advice®. Interpreted to mean if you want to keep your assets, then take my advice.

Thank you for being a client and if you are not a client, then perhaps you might want to be.

Investing Pundits

I am always fascinated watching these "investment advice givers" on television and their view of "what to do now." In addition, there are a group of people who routinely appear on television and in the Wall Street Journal and other print publications. The producers and journalists have their trusty list of contacts and they always seem to use the same people. The question is always the same. "Where should people put their money now?"

The answer is usually targeted to the kinds of clients that the person being interviewed has in their business. Rarely ever, is the advice good advice for the general public. There is a reason for this fact. This reason is that there is no good advice for the general public. Each individual's circumstances are different and the advice should also be different.

There are times, however, when advice can be consistent for all. In the year 2008, I had enough of the insanity going on at the time, so on October 6th, 2008, I went to 100% cash. This decision was easy for me. It is my job to protect my client's assets in the best possible manner. This is what I did back then.

Fast forward to the recent past. On August 8th, 2011, approximately one month ago, I sold all equity investments in our client's accounts. I kept short term bonds, gold, managed futures and commodities for those who already held these in their accounts. Some clients I kept 100% in cash, because it did not make sense to run up transactions costs. Nor did it make sense to buy assets classes like Gold when they had already run up so much.

So, why did I do this again?

I evaluated the world's economies, along with my partner, Stan Rosenthal and after validating what we believe to be happening right now, we made the decisions that we did. By evaluating the world's economies, this is what I mean:

Europe has shown an unwillingness to really address their fiscal problems and uniformity of austerity decisions seems unlikely. I believe that the markets will force their hand. United States institutions most likely hold European sovereign debt. Sovereign debt is debt issued by the country in question. Such as Greek debt, Italy debt and so on. If the U.S. is currently holding the sovereign debt of Europe, then there will be a domino effect on our markets. Do we know how much sovereign debt our institutions hold today? Does anyone really know for certain? No, I do not think so. Therefore, it stands to reason if Europe goes, then so goes the world economies, including the U.S. A double dip recession would be certain.

Another concern of mine is China. Can we really trust what the government of China says? I look at the U.S. economy and I see a stark lack of demand. The lament from all businesses is that we do not have the demand. It does not take a smart fellow to figure out that if our businesses are not seeing the demand, then can China continue to export their products to our economy without any demand? I do not think so. They have to be feeling the effects of our lack of demand.

In addition, in China, they appear to be having a real estate bubble. They have built and overbuilt buildings for the anticipated growth of their economy. I suspect that the Chinese government will institute some controls to slow things down a little, but being a true neophyte on capitalism, I doubt that they will be able to control things like they think. There is a business cycle of booms and busts and there always will be. It makes no difference if it is China, the U.S. or any other capitalism based country.

When you factor in the political implications of Washington, D.C. politicians, overly burdensome regulations, the government trying to "make the banks pay" for 2008, then you have all these things combine to make you want to call a timeout.

Now, they are talking about "writing down" mortgages to currently appraised values. This means that there are going to be a lot of losses if this happens. Who is going to decide whose mortgage gets written down and whose doesn't? I can see lots of real estate investors and banks losing lots of money if this happens. This will not be good if it does. Lawsuits will come flying from everywhere. You wait and see.

Technical analysis is something that I follow very strongly. I look at Technical Analysis on new housing sales, existing home sales, employment trends, retail sales, manufacturing, GDP and other areas. Other people look at the numbers. It is better to look at the charts, because you can clearly see the trends. Nothing in these charts gives me "turnaround confidence".

Further, when I look at the major indexes from a Technical Analysis standpoint, I see a waterfall in August and an attempt to establish a base in September. A waterfall is where the price of the index drops off a cliff similar to a real waterfall. A base in technical analysis terms is when the price of the index is going sideways. There appears to be a ceiling on the upside, or not enough buying volume to sustain upward momentum. In addition, we are into an uncanny period of moves up and down over triple digits. Contrary to popular belief, this is not the "new normal".

These investment pundits trot out there everyday and say "this is a good buying opportunity." Hogwash! They also talk about "missing out on a great return." More Hogwash! What great return has the market given us over the last 10 years?

Here is something to really think about. The Baby Boomers are getting into their retirement years. I doubt very seriously that they will be holding 80, 90 or 100% stocks as they get closer to retirement. This means that they will be selling. There will be lots of selling. In my mind, in order to be successful in a selling environment, (like this country has never seen before), you are going to have to pick your spots. Sometimes, you have to go against the status quo of advice you hear on television and read in publications.

I'm afraid that in order to be successful at advising clients on their investments, then you are going to have to be prepared to sit on the sidelines sometimes. So, what if you sit in cash for a few months. You will still have that cash after a few months. The trick, as I discuss in detail in my book, is to not take big losses. Also, you never want to hold 80, 90 or 100% in equities.

Keep Your Assets. Take My Advice. It is Easier to Climb Out of a Shallow Hole.

Good advice for all.