If you are like most investors, you prefer to talk about good performance years and avoid discussions about bad years. Well, you have had a lot to talk about the past few years, but there are some serious storm clouds on the horizon. Now is the right time to waterproof your investment strategy.
Good Times
The Dow Jones Industrial Average is one of the most frequently used proxies for the performance of the stock market. It is not the most comprehensive index, but it illustrates the point I am trying to make.
The Dow has been on a roll since the devastating 33.8 percent decline in value that occurred in 2008. The past five years have all been positive: 2009 (+18.8 percent), 2010 (+11.0 percent), 2011 (+5.5 percent), 2012 (+7.3 percent), 2013 (+26.5 percent). 2014 looks like it will end-up being the sixth positive year in a row (YTD: +8.6 percent).
The past five full years, the Dow has produced a 13.8 percent annual rate of return. The more money you had invested in the stock market on January 1, 2009, the bigger your bank account is today.
Let the good times roll!
Storm Clouds
The reality is all of the securities markets run in cycles. Our slow climb out of the Wall Street induced stock market collapse and recession has produced years of positive returns. But, this current cycle is getting a little long in the tooth. Our economy continues to grow at a robust rate. Jobs are increasing with economic growth. It is only a matter of time until interest rates rise to reduce the risk of an over-heated economy.
The real axe is any unexpected threat that undermines the good times. The uncertainty could start in the Ukraine, China, or the Middle East. In a global economy it does not matter where it starts. The ripple effects impact the inter-connected, worldwide securities markets.
Behavioral Investing
It is hard to think about bad times when your assets have been producing positive rates of return for six consecutive years. In fact, there is even an old saying on Wall Street that describes this type of behavior: "When times are good, people believe the good times will last forever." That is never true. We live in a cyclical world that repeats itself time and time again.
I know it is hard to think about fixing the roof when the sun is out. But, it is usually too late to fix it after the rain starts. You will have some water damage. The only question is how much?
Your Financial Adviser
Advisers create high, continuous performance expectations. They use this tactic to justify the high fees and commissions that they deduct from your accounts. It is tough to sell 4 percent rates of return when expenses are 3 percent. It is much easier to sell high expenses when anticipated returns are 14 percent or more.
Most advisers are reluctant to talk about risk because it equates to financial losses and it is even tougher to justify big fees for negative rates of return. There is a consequence. You, not the adviser, suffer serious losses if you fail to reduce your exposure to financial risk.
The Prudent Investor
Given all of the information that is available to you, what would a prudent investor do in like circumstances?
In January you will be meeting with your financial adviser to discuss your 2014 results. After the discussion about "Good Times" ask your adviser to describe his strategy for protecting the value of your assets during "Bad Times."
About the Author: Jack Waymire worked in the financial services industry for 28 years. For 21 years he was the president and chief investment officer of a registered investment advisory firm. He left the industry in 2003 when his book, Who's Watching Your Money?, was published by Wiley & Sons. In 2004 he launched an investor education website, www.PaladinRegistry.com, that was based on the principles in his book. A Registry of vetted, rated financial advisors was added to the website in late 2004. Jack is a columnist for Worth magazine, a frequent blogger on major financial sites, and is widely quoted in the media including the Wall Street Journal, Forbes, BusinessWeek, Bloomberg, and Kiplinger. Follow Jack on Twitter @PaladinRegistry or email Jack@PaladinRegistry.com.