Dread

by David Jeter, CFP®, Senior Vice President
September 2011

[drĕd] verb: to fear greatly; to feel extreme reluctance to meet or face

The beginning of September is always big in the Jeter household. Our children start the school year and, within little more than a week, three of us have birthdays—two kinds of events with a common refrain. From my son and daughter, “I dread starting school again.” And from yours truly, “I dread another birthday.” My wife is the sole cheery one, maybe in part because she is so easily mistaken for an ‘oldest daughter’ of mine.

Dread. The word doesn’t fool you at all. It sounds as bad as what it denotes. One syllable and straight to the point, beginning and ending with a thud. It can be a choice, of course, not to dread something. And not to let it guide your decisions.

Everyone with savings and investments has just experienced a jolting, apparently contradictory set of events. In the past couple of months, shortly after the 500 largest U.S. companies reported, in aggregate, profit margins, cash flows, cash positions, and gross profits at the highest levels ever, the prices of their stocks were pummeled. The financial situation of these large, healthy companies didn’t change. What did? The world focused on government dis-function, in Europe and the U.S. The environment for companies was very different from 2008, but talk of a repeat scenario was everywhere.

A sell-off ensued. . . and dread set in.

The siren song of cash
That dread led many to consider a run to cash. And I am referring to investors with long-term investments here, not market traders with short-term strategies. But cash is not a viable long-term asset. People often assume it earns at least 0%. In fact, it typically loses real value. If your money market account pays 0.1% and inflation is 2% a year, your real annual return is -1.9%. If your account pays 2.5% and inflation is 5%, your real return is -2.5%. Run that calculation out for a few years and you see what really deserves the feeling of dread.

The run to cash for long-term investments is ‘fear in action.’ The only reason to put long-term funds in cash is that you think everything else will be worth less than cash in the long run, and you personally have no way of reconciling your fear or assumption. It’s the way many people feel about flying in a plane. They hear the stats about planes being safer than cars, but they don’t understand why, and they fear because they lack control. In a car they control something – the steering wheel.

So they consider to move to cash “until things settle down”—as if you were pulling over to the side of the road until the downpour subsides. But financial markets don’t behave like a storm passing overhead. And when recovery follows, gains are greatest in the first few months. The investors waiting on the shoulder have been drubbed and doused. Rarely do they get back in without damage when the market storm passes.

Cash provides the illusionary comfort of the steering wheel, and turning onto the shoulder is not safety in this case. Converting long-term investments to cash is exactly counter to long-term objectives: growth of capital to maintain purchasing power. Rushing to cash, we act upon our current fear at the risk of our long-term need. Don’t do that.

The reassurance of perspective
The U. S. stock market has gained value in 24 of the past 30 years. During those 24 years, though, the market experienced intra-year declines—averaging -14%. So far in 2011 we’ve seen a decline of 18%. In other words, not much is different this time. It’s the typical pattern: we have an annual “impending doom” . . . and then we don’t.

It is easy to get caught up in 24-hour news cycles. “Nothing to see here, ma’am” would never do on CNBC or any other news station looking to capture and hold your interest. Hearing something “plummeted,” “crashed,” “surged”, or “rocketed” stirs us more than hearing it “increased” or “decreased” for a while. But market reports are not an investment philosophy. This bears repeating: there is a critical difference between a market outlook and an investment philosophy.

An additional challenge is not only the words used to stir us, but the instantaneous imagery delivered to us through iPads, iPhones, Droids, and Blackberrys; let alone unfiltered information through Facebook and Twitter. Everything works against our already naturally bad investing instincts. We confuse risk and uncertainty. We read articles about traders and overlay our experience as investors. We are overly euphoric when the market is up and overly tragic when it falls. Our DNA tells us to pay attention to the bad more than the good, just like it did thousands of years ago. Helpful in the Paleolithic Period, not so much in the investing world.

So what do facts, figures, and historical record support? Thornburg Investment Management produces a Real Return Study each year (Real Return defined as Nominal Return minus assumptions for capital gains taxes, dividend/interest taxes, expenses, and inflation). For the 20 year period ending December 31, 2010 U.S Large Cap Stocks returned an annual average of 4.82%; US Small Cap Stocks an average of 6.5%; and International Stocks 4.54%. During the same period US Treasury Bills averaged -.85% annually.*

My purpose is not to be an apologist for what has been a rough period in the stock market. In fact, there are other holdings we have in portfolios in addition to equities to help you capture and preserve long-term growth of capital. Nor is it to deny anyone their feelings; that is neither fair nor realistic. My purpose is to help people put themselves in a position over the next several decades, not months, to achieve their financial objectives. To this end, dispassionate consideration of facts, numbers and the historical record is a better basis for decision-making than the imperatives of dread.

For those that consistently receive my write-ups this will all appear quite repetitive, and in fact it is. I am not suggesting that the market is poised to jump higher or fall further any day now. Like everyone else, I don’t know. But similar to most areas of life, there is a big difference between staying consistent and doing nothing.

What this means is a continuous battle over our terrible investing instincts. I am not suggesting that one ignores our current situation, but I am suggesting the lens through which you view it changes. Instead of asking “What will the market do today?” (or worse “What will the news say about what the market will do today?”) I suggest asking, “Dread not….what are my financial objectives?”

—David Jeter, Senior Vice President, Allegheny Financial Group, 412.367.3880, djeter@alleghenyfinancial.com