The above introductory comments are edited excerpts from an article* by Richard Russo, CFP, (moneymusethoughts.wordpress.com) entitled Reversion to the Mean is a Bitch – 3 Ways to Avoid Getting Killed When The Next Market Pullback Occurs.
The following article is presented courtesy of Lorimer Wilson, editor of www.munKNEE.com (Your Key to Making Money!), and www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and has been edited, abridged and/or reformatted (some sub-titles and bold/italics emphases) for the sake of clarity and brevity to ensure a fast and easy read. This paragraph must be included in any article re-posting to avoid copyright infringement.
Russo goes on to say in further edited excerpts:
Below are Lance Robert’s rules as to why it’s impossible (along with my commentary). I follow up by adding 3 ways to let you keep yourself in check as markets eventually revert to a mean.
“While Wall Street wants you to compare your portfolio to the ‘index’ so that you will continue to keep money in motion, which creates fees for Wall Street, the reality is that you can NEVER beat a ‘benchmark index’ over a long period. This is due to the following reasons:
- The index contains no cash – and you should always have cash. Cash is an asset class, cash is for withdrawals, cash is the ultimate diversification, cash is there to make attractive purchases.
- It has no life expectancy requirements – but you do. Stocks for the long term? Can you wait 30 years to break even when you purchase at lofty valuations? NO.
- It does not have to compensate for distributions to meet living requirements – but you do. You also should maintain two years worth of distributions aside for living expenses in retirement.
- It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance – this is fine on the way up, but not on the way down. Losses are tougher to make up. If you lose 50% you’ll need 100% to get back to even.
- It has no taxes, costs or other expenses associated with it – but you do. If you invest you’re gonna have fees, commissions. There is no free lunch when it comes to expenses.
- It has the ability to substitute at no penalty – but you don’t. Commissions, taxes will drag on returns.
- It benefits from share buybacks – but you don’t. On occasion you benefit from a stock that now has better EPS due to buybacks, however, there’s no consistency to this for you.
In order to win the long term investing game, your portfolio should be built around the things that matter most and beating an index isn’t one of them. It’s great for cocktail party conversation…but that’s about it.
Here’s what’s important. Never forget:
- Capital preservation (A lost opportunity is more easily replaced than lost capital).
- A rate of return sufficient to keep pace with the rate of inflation.
- Expectations based on realistic objectives. (The market does not compound at 8%, 6% or 4%. Losses destroy the effects of compounding returns).
- Higher rates of return require an exponential increase in the underlying risk profile. This tends not to work out well.
- You can replace lost capital – but you can’t replace lost time. Time is a precious commodity that you cannot afford to waste.
- Portfolios are time-frame specific. If you have 5-years to retirement, but build a portfolio with a 20-year time horizon (taking on more risk), the results will likely be disastrous.
Three ways to avoid losing your ass, right now:
1). If you must commit capital to stocks 5 years after the financial crisis, go SMALL
Let’s face it: You missed the big ship. Go for the dinghy and be happy. Keep your stock allocations below 50%. Keep the rest in short term fixed income or yes, cash.
2). Work with an advisor who will calculate your required return
Establish a personal benchmark and then work backwards into the asset allocation plan. Most financial consultants are there to sell you product, not to calculate your desired return. Remember, too, that generating return takes work on your part, too – increased savings, lower debt-to-income household ratios. working longer. There’s no sexy magic here. If you’re being sold an investment first: WALK.
3). Now is the time to stop listening to friends and family about stocks
The extremes in sentiments will confuse you. Aunt Millie sold out in 2009 and won’t go back. She’s awaiting the “big one,” the crash. Joe went “all in” two years ago and is up a billion percent. There’s a happy medium. Cut the noise. Create rules, work the numbers. Understand where you are behaviorally when it comes to risk. [Go to riskprofiling.com]…pay the 40 bucks, take the test and bring the results to your advisor...
- Be thankful for good advice…
- Know your limitations.
- Accept who you are from a risk perspective.
- Work with an objective financial partner who listens to you.
- Get your ego out of your portfolio.
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
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