It was the compass that did it. I had decided to go “off book” in the 9th-grade Junior Achievement class I was teaching at Avonworth High School, just north of Pittsburgh. The subject was Business Ethics, but we talked about a compass, what it is and what it does. The entire class knew it tells direction—north, south, east, and west. Many knew how it did this—by a magnetic orientation to the earth, showing north. From there we talked about the relation between the magnetic north heading of the compass and true north.

At this point I wanted to challenge them. What if you buy a compass at the Target across the road in Pittsburgh, but want to use it in Florida on vacation? Will you have a problem? Will you need to buy a compass in Florida to get the correct directions? In a show of hands most of the class agreed that a new compass was needed—not all, but most. Okay, I asked, what if you find yourself in Europe, an entirely different continent with different measures for many things? Will you need another new compass? Everyone, except just three members of the class, agreed that a new compass was needed.

I asked those three if they were confident enough to wager on their belief. They didn’t flinch. I upped the hypothetical ante, . . . but they didn’t flinch. Then I asked them why they were so certain that they were right, in the face of the overwhelming opinion of the class. Sam put it simply,” Mr. Jeter, it doesn’t matter where you are, north is north.”

For help with directions in unfamiliar terrain – a compass
At this point the rest of the class gave a collective slap to their foreheads as the light went on. I took the opportunity to shift the discussion from a physical compass to a moral compass, an ethics compass – a code of behavior for making decisions in life. With this compass, dilemmas are not necessarily easy to solve, but they are clearer. To their credit, the class was on top of it this time. They understood that having a compass for decision-making about what to do, how to act, in unfamiliar territory and uncertain situations is a pretty good idea, making critical choices less a whim and more a process.

I’ve been volunteer teaching for several years for Junior Achievement in the Pittsburgh area—teaching six-week segments on topics such as personal finance, entrepreneurship and economic development, and the American role in the global economy. I started volunteering as a way to give something back to the community in gratitude for my own good fortune. But I almost always come away with at least as much as the students.

As I left school and got in my car that day a month ago, I mulled on all the areas of life—school, raising children, being effective with clients, and certainly making financial decisions—that benefit from knowing where you want to go and having clear direction.

That thought was still in my head as I considered how 2009 went for my clients and what may lie ahead in 2010. In my opinion the economic and financial upheavals of the past two years have confirmed the value of a financial compass, with its unvarying directions. The stock-market plunge last March led many people to question every investment theory from the past. The market’s 60+% rise since then should have answered some of those questions. I am certain many people are now again observing some of the financial laws of nature they may have ignored. Here are just a few of the points on the financial compass that have served my clients and me well during the turbulence.

Spend energy on what you can control, not on what you cannot.
• Example number one is spending itself. Spending less than you take in sounds elementary, but demands vigilance, effort and will. The principle is not just personal. Your investments should be in companies, entities and governments that follow the same precept.

  • Remember the flip side of spending: decide how much you will save. Determining savings first and saving consistently assures that even if the economy remains bogged down for a while and your current investments take a long time to re-gain value, you will have more money than when the financial-markets slump started.
  • Know what invested money is for. Investing just for the sake of having more money is a danger. If the money has a purpose and that purpose has a date attached to it, success and failure is in your control, not in the markets.

Do a tax projection during the year. Understanding what your tax liabilities are and assessing ways to limit your potential burden can be an effective exercise. For example, you are probably reading about 2010 opportunities to convert to a Roth IRA. Does it makes sense for you? Only way to find out is to examine it.

Review your estate planning and beneficiary designations. Regardless whether changes have been personal, from family dynamics, or legislative, it makes sense to be sure wills, trusts, powers of attorney, and beneficiaries listed on your retirement plans and insurance do what you’d like them to do.

Review protection. The stock market, the Treasury Department, and Ben Bernanke have nothing to do with protecting your family from an unplanned event. How do your employee benefits provide for you? How does that change if you have a change of employment status? Do you cover the things you desire to protect in the event of a disability or premature death?

Make your time frame a major determinant of your investments. Equities, for example, are for the long term. And short-term volatility in equities should be expected, even welcomed for the opportunities presented, not taken as a reason to run for the exits. So far, this past bear market is acting just like previous ones: an initial rumble, followed by a blowout drop, and a vigorous recovery in the ensuing 6-12 months. If one is to be invested in equities for the long term, and long term means at least 5 years, then we are not half way through an appropriate measure of performance. I am not suggesting that all is well and a new bull market is in progress. My clients know I have some deep concerns in the short run. What I am suggesting is that on the surface, the market has in fact gained over 60% from its low, and those who ran for the exits did so with a cost to their future.

Recognize the importance of inflation, taxes and costs in determining long-term investment performance. Thanks to inflation, you can be certain that putting everything in CD’s or money-market accounts means you will be poorer in the long run. On the other hand, trying for gains by trading securities frequently will also likely erode the value of your investment portfolio. And while tax considerations shouldn’t drive investment decisions, ignoring the consequences of taxes (yes, they’re going up) will cost you.

Invest with managers that have skin in the game—that is, with money managers that have their net worth tied up in same things as you. Without questioning anyone’s integrity, experience has taught me that managers that eat their own cooking provide returns far superior to their peers who do not—even when the latter charge less.

Diversify, because leaders and laggards are only determined in hindsight. Markets bottom and hit highs as part of the normal, macro-economic cycle. One asset class heats up and one cools off. No one can predict with certainty when any of this occurs. You can know Treasury rates will increase in the future (they have, too!), but you don’t know when and how much. You can know that the current stock-market rally has been led by “the dogs” and that a rotation to quality companies is going to happen, but you don’t know when. You may have known that Emerging Markets were going to take off last year, but you don’t know when they will flag. All investments move into and out of favor, but neither the date of the change nor the name of the investment is published beforehand. Fortunes have been lost quickly by trying to guess. Trying to hit home runs like the ones you sometimes read about in the newspaper is a losing game. Wealth is most assuredly built slowly, over the long term, by spreading risk.

Recognize that any investor can look clueless in any 3- to 6-month period, but over economic cycles the competent rise to the top.

As Sam and his two independent-thinking classmates pointed out, “north is north.”

Author: David Jeter, CFP®, Allegheny Financial Group, January 2010

Securities offered through Allegheny Investments, LTD, a registered broker/dealer. Member FINRA/SIPC.
The above comments are provided for discussion purposes only and are not meant to be an offer of any specific investment.