Investing in a Volatile Market

CINDY SANDERS

Investing in a Volatile Market | Stephen High, Brad Pendleton, Grant Ellis, Merrill Lynch, Kraft Asset Management, Ellis Benefits Group, investing, investments, stock market, retirement planning, assets, asset safety, recession, volatile market, financial advisor

Stephen High
As tempting as it might seem, most financial experts agree that assuming a fetal position is not the most effective way to ride out today's volatile market.

"People have different levels of risk tolerance," noted Stephen High, CPA, JD, PFS, chief manager for Kraft Asset Management LLC. "But even those with high levels of risk tolerance are pretty concerned."

Still, for those with the intestinal fortitude, the current market situation offers a unique opportunity to purchase a share of many companies and funds at clearance sale prices.

"Right now the perceived risk is high, but when risks are high so are potential returns. Stocks are the only thing people don't want to buy at a bargain," High noted of human nature.

"If you have a decent amount of time to retirement, now is one of the best times in history to invest in the stock market and equities market. Everything in the country is on sale right now," echoed Grant Ellis, QKA, of Ellis Benefits Group, Inc. His retirement plan consulting company, which is based in Cordova, Tenn., is expanding to Middle Tennessee with the opening of their Nashville office this June.

The qualified 401(k) administrator added the market is showing some signs of settling down. However, he said there's no way of knowing if it has hit bottom yet and cautioned investors to expect a long road ahead as the market corrects. "There's going to be a return to very sound, ethical business practices, which in my opinion presents an opportunity to the investor," Ellis said.

Brad Pendleton, CFA, senior financial advisor in the Nashville office of Merrill Lynch, noted the recent freefall in portfolio values has been frightening to many investors who have sold off chunks of their investments in response. "People who are selling into this market bought high and are selling low," Pendleton cautioned. "This is a buying opportunity. Yields on high quality corporate bonds are attractive."

'Buy now' isn't the only point on which these advisors concurred. All three also stressed the importance of a diverse portfolio. As Pendleton put it, "Going back to our grandparents' wisdom –– don't put all your eggs in any one basket."

He continued, "Probably the biggest mistake I see in my practice is people who want to sell out when the market is low, and the second biggest mistake I see is refusing to diversify a concentrated stock position."

Although each of the financial advisors has different ideas about the best way to move their clients toward stated objectives, another point of commonality among the three is the need to fully outline those objectives and personal goals and to craft a strategy that is unique to the individual investor. Each helps clients decide on a percentage of investments in the various asset classes such as large and small cap companies, fixed income products, REITs or commodities. Each also acknowledged wealth strategies invariably have to be rebalanced as life events dictate.

"When you are helping people with their portfolios, it's a very personalized process … and has to be. You cannot take a cookie cutter approach," said High. He added that it is imperative to sit down with a client and really understand where they are right now and where they hope to be five, 10, 20, 30 years down the road. "The whole point of the portfolio design is to bridge that gap."

Due diligence with a client on the front end helps weather the inevitable market shifts.

"The greatest pieces of information I can get from a client are 1) their cash flow needs … the more clearly that is mapped out, the more clearly we can set a strategy … and 2) an honest assessment of their risk tolerance," said Pendleton.

Gauging that tolerance level dictates an investment style that is either more active or passive in nature. Both styles offer risks and rewards.

High's company takes a more passive approach … although he prefers the term "structured asset class approach." He said, "We don't typically invest in stocks unless the client wants us to, but even then we limit the number of investments in their portfolio. We believe it is less risky to invest in mutual funds because mutual funds are typically more broadly diversified. People have to own a tremendous number of individual stocks to be truly diversified."

He added the advisors at Kraft Asset Management prefer to use index or index-like mutual funds because of the lower associated costs rather than mutual funds with front- or back-end loads. "Everything else being equal, you make more if you can control costs," he pointed out. "Ours is a very disciplined approach to investing," he continued.

Using a baseball analogy, High said, "We hit singles, doubles … maybe a few triples. We're not swinging for the fences, but when the market is down, we're not striking out as much either. We have a consistent batting average."

High cautioned an active approach often leaves people chasing returns and too often results in buying high and selling low as they mistime the market. He readily admits an investor might have a lucky gamble pay off. But, he continued, "Like Vegas, it's hard over time to beat the house."

Pendleton, on the other hand, sees the benefit in a more aggressive investment strategy for most clients. "A passive approach to investing will simply follow an index so the returns that investor will experience will be tied to the index. Whereas an active management style will either seek to outperform the index or be more defensive than the index. It's a way to bring an individualized solution to a client."

It's Darkest Before the Dawn


Lessons from Other Bear Markets

While readily acknowledging the devastation of the current economic downturn, Stephen High, chief manager for Kraft Asset Management LLC, noted there are some positive historic trends that should encourage investors to once again become bullish on America's long-term financial outlook.

Putting the current recession into historic perspective, High said, "As bad as 2008 was, the worst 12 months on the S&P 500 was July 1931-June 1932 when it lost 67.6 percent... but," he continued, "interestingly enough the best 12 months happened right after when the S&P 500 had a return of 162.9 percent."

He added that during the last 11 recessions, which have occurred since World War II, the S&P index rose, on average, 7.5 percent … outperforming treasury bills. Conversely, during that same time period, the S&P rose only 2.1 percent when the economy was booming and America was considered fully employed.

High noted the stock market is priced on what investors know and what they expect. If bad news is anticipated, the fulfillment of that prediction doesn't necessarily mean a major downturn in stock prices … and values can actually rise if the news isn't as bad as feared. Typically, he continued, the markets begin an upswing before the country actually pulls out of recession.

"The stock market is actually a leading indicator of the economy," High explained. "On average, the stock market turns about six months ahead of the economy. Unemployment is a lagging indicator of the economy. On average, unemployment is a nine-month lagging indicator so unemployment lags the stock market by 15 months."


It is certainly possible, he added, to choose less volatile options within the equity markets for clients who have a lower risk tolerance level. Bottom line, Pendleton concluded, "A good portfolio should be diversified whether you go in active or passive."

Great, But Will I Ever Be Able to Retire?

Retirement expert Ellis said the current market conditions have changed the game plan for many.

"For those close to retirement, there are really two answers. The first and best option for most people is to work longer. The people who haven't sold their money out of the market haven't officially lost money, yet. The value of the shares is lower, but they have the opportunity … when the market rebounds … to gain that value back. But it's going to take time.

Ellis continued, for those planning to retire in the next one-to-three years, the second answer is to preserve your remaining assets. "You need to move your assets to cash as quickly as possible to avoid any further losses." He suggested moving into conservative investments such as bonds, treasury bills and money market accounts. Again, however, he stressed the best solution might be to put off retirement for a few years in order to ensure you don't outlive your assets. "If you have time to recoup gains that you may have lost prior to retirement, then the logical stance is to stay invested."

Ellis noted that age 50 has been a traditional time to begin shifting into more conservative investments. In the past decade, however, financial advisors have encouraged people to keep more of their equity exposure longer. Given the current market, he questioned whether or not that strategy would continue.

Pendleton said it's important to reposition your portfolio when life events dictate. Although a typical investor does slowly increase the proportions of cash and fixed income, he pointed out not every client gets less aggressive as they age.

"Ideally at retirement, I would like clients to have 18 months of cash needs," Pendleton said. "Stocks are still absolutely an appropriate component of a retiree's portfolio," he continued. "Just because you are retired doesn't mean you don't still need growth. You can outlive your money. You can lose purchasing power."

Pendleton added that human nature is to guard against the last tsunami … in this instance the market correction and credit meltdown. "We tend to forget or discount that there are other tsunamis out there so we'll underexpose ourselves to stock and overexpose ourselves to fixed income and cash. The tsunami that wipes those out is inflation. By having a diverse portfolio, you tend to guard against unknown future risks."

While all three financial advisors agreed there isn't one solution that fits everyone, each stated emphatically that everyone needs to think through their own financial objectives on the front end rather than making decisions in the heat of the moment … whether the "moment" is an up tick in the market or a downward spiral.

"What we've learned is that a financial plan is more important than ever," concluded Ellis. "It takes the emotions out of investing."