A Five Question Portfolio Check Up

1.  If the stock or bond market has another panic attack and drops 25% to 50% in the next 1, 2 or 3 years, would this decline make you unable to pay off your mortgage, pay for college, or whatever else you planned on doing?
2.  If the stock or bond market has another panic attack and drops 25% to 50% in the next 1, 2 or 3 years, would this decline cause you to: panic, sell everything you own, or worse, jump off a bridge?
3.  Do you know what you own?
4.  How important is the result of your portfolio entrusted to us in light of your entire financial well being?
5.  Do you know the legal requirements of your portfolio?

At 55 years old and counting, the bridge was designed to withstand the abuse of ¼ of today’s traffic load.  The builders must have followed the Warren Buffet rule, if you are going to build a bridge, “[...] you build a bridge that 30,000 pound trucks can go across and then you drive 10,000 pound trucks across it.”  The problem is that the bridge is now expected to handle those 30,000 pound trucks without a problem.

Many of us designed our portfolios years ago, never expecting 0% interest rates or 50% market crashes.  I am happy to say that the original design held up, but unlike our SCDOT, we do not have to wait, nor should we wait, for an unauthorized or unwelcomed 50,000 pound truck to join us as we drive across our 30,000 pound bridge and send us both crashing onto the C.N. and L. Railroad tracks.

Most of us will have a major objective that falls into one of three categories: income, growth of capital, or a combination of income and growth.  In addition to these major objectives, each of us will have a different time period for when our money will be needed.  This time period may be known in advance or it may not.  Our need for our funds may have a specific dollar amount that we can estimate with a high degree of accuracy, or it may not. 

For example, we may have a fixed rate mortgage that we would like to pay off in ten years and would like our portfolio to provide the funds to meet this need.  On the other hand we may need our portfolio to provide an income stream beginning in five years to supplement our retirement.  This creates a problem.  With the mortgage, we have a known amount with a date that the funds must be available. However, with retirement, we do not know what interest rates will be five years forward, nor do we know what amount of money we will need to supplement our retirement as the cost of living changes over time.

Some of you may want to live well while there are a few of you that simply want to sleep well.  As we move a portfolio from one designed to allow you to sleep well to one designed to live well, we have to increase the amount of risk taken.  Today, as it has been for decades, without a big dose of luck, it is impossible to have your cake and eat it too.

We are a research driven Investment Company.  Our days are spent doing the work many would describe as boring.  Crunching numbers, reading academic papers, looking at company reports, determining a fair value on each holding and accomplishing the day to day requirements needed to maintain the integrity of your portfolio.    You should expect this from us, but we do need your help if your real needs have changed.  Here are five questions that we encourage you to answer with a few comments to guide you:  

Question Number 1:  If the stock or bond market has another panic attack and drops 25% to 50% in the next 1, 2 or 3 years would this decline make you unable to pay your mortgage off, pay for college, or whatever else you planned on?

I am not suggesting that the markets will fall to this degree; however, we do not have a crystal ball.  If you have an obligation that will require a fixed amount of funds in a short period of time, all effort should be made to limit any market risk on the needed funds.  Just as importantly, you must make sure that the funds will be available when needed.  With today’s interest rates that is tough to take, but I believe it’s necessary.  

Question Number 2:  If the stock or bond market has another panic attack and drops 25% to 50% in the next 1, 2 or 3 years, would this decline cause you to: panic, sell everything you own, or worse, jump off a bridge?

Once again, I am not suggesting that the markets will fall to this degree; however, it is important to recognize the possibility of a decline of this magnitude.  Our long term clients have experienced this and I am thankful to say that they have weathered the storm.  Because I have personally gone through every major panic attack in the last thirty years I have built up an immunity to market fluctuations.  Even with these immunities I still worry for each of you and suggest that you talk to us about your feelings now, not later.  Although adjusting a portfolio to reduce the impact of market fluctuations will reduce expected returns, if it stops you from joining the sell low club, then it is worth it.

Question Number 3:  We have used the tag line “common sense investment management for conservative investors” for many years.  Our definition of conservative does not mean the absence of risk.  It means to understand what you own and why.  Do you know what you own and why?

There is very little common sense in investing.  In fact, the greatest opportunities for a long term investor come during times of market distress.  As a firm we would like to buy when others are selling and sell when others are buying.  The only way we can do this is to fully understand what we own and why.  By knowing what we own we have a great advantage over those who panic and sell at the bottom, or who buy at the top because everyone else is making easy money. 

For example:  In 2007 we purchased shares of Colgate Palmolive.  In the middle of the 2008 to 2009 panic the market value of Colgate declined by over 25%.  I could have, just as easily, followed the crowd and said that the end of the world was here and because Colgate had declined it would continue and soon become worthless.  But I knew that Colgate had been in business longer than I had been alive, that they had not only paid me a dividend, they have increased it every year for years.  I knew that they did business in over 200 countries.  Just as importantly, I was certain that people would continue to brush their teeth, take a shower, wash their cloths, clean their home and feed their pets no matter what was going on in the market.  This knowledge of the company kept me from selling my ownership in this great company at a ridiculously low price.

Every month you receive a statement from your broker that lists what you own.  Every quarter you receive a statement from us that lists what you own.  Take the time to look over your holdings.  If you have any questions on what you own and why, then give us a call.  Knowledge will help you make sense of investing.

Question Number 4:  How important are the results of the portfolio(s) you’ve entrusted to us in light of your entire financial well being?

When we first sat down with each you, we built a very simple balance sheet; a list of what you own and what you owe.  At the same time, we built a very simple income statement; a list of where your money comes from and where it goes.  Of course, this only represents a single point in time.  For those of you who are working and adding to your retirement plan, the value of that plan is certainly different than when we built your statements.  For those of you who are retired, your pension, including social security may have changed.  Maybe you have paid off a bill or two, or had a new bill or two come your way.   We need to make sure that what you have entrusted us to take care of is working as hard as it can for your benefit.  In all cases, if a material change has taken place in your overall financial position that you believe impacts what we are doing for you, then please, give us call. 

Question Number 5:  Some portfolios are subject to IRS and ERISA rules.  Some portfolios are owned by a trust and must follow the rules established by the trust itself.  Some endowment funds have a legal duty to spend a portion of the funds independent of any earnings.  Do you know the legal requirements of your portfolio?

Breaking any legal requirement can cause more pain than a panic sell off in the markets.  With the assistance available to you from your professionals, including ourselves, we can put our heads together to create an investment program that I hope would not violate the rules.  Of course, we cannot help unless we know what rules you and your portfolio are subject to.  Call us if you have concerns.

Until next time,

Kendall J. Anderson, CFA