Dealing with stress in your portfolio

Have you ever felt anxious about your investment portfolio?  Who hasn't?  A recent presentation at one of our professional conferences pointed out that five out of every six years will produce a stock market return sequence that either triggers anxiety or smacks your portfolio so hard that you wonder why you ever trusted the markets to begin with. 

This is normal.  Many people simply cannot handle stock market volatility, which is why the people who can have historically tended to make more, over multiple ups and downs, than the people who kept all their money stashed away in Treasury bonds. 

The question is: is there a better way to handle the inevitable anxiety that comes with buying stocks?

Psychologist Ken Haman, who now works at the investment firm AllianceBernstein, says that the key is to stay rational.  He points to studies of the human brain, which show that all of us actually have two brains.  One is the neocortex, where all of your higher thought processes take place.  Below the neocortex is a primitive brain which is about as smart as an alligator; and this lower brain happens to be where all of our survival instincts are housed. 

Whenever you experience panic, the primitive brain immediately takes over and shuts down the neocortex--which allows you to respond instantly (rather than thoughtfully) on those many occasions when a saber-toothed tiger is running in your direction. 

So when the markets have spent the past quarter giving up all the gains they generated in the first quarter, what do you do?  First, talk with somebody who actually listens to you about how you're feeling.  Then start to engage your neocortex.  What do you imagine is going to happen in the future?  Then move to: is that what you think, or how it feels?

If you're talking with a professional advisor, the advisor can guide you through this process, and then, when your neocortex is functioning again, you can look at some of the past market declines and see what happened next, or look at your financial situation and take stock of your progress toward your financial goals.

People who can handle the stock market roller coaster without getting sick seem to have an unfair advantage over everybody else in the investment world.  It seems to depend on which part of your brain is in control.

Have a great week!

What Are We Thinking?

2010 marks the 25th anniversary of the Certified Financial Planner Board of Standards, which grants the CFP^® certification and upholds it as the recognized standard of excellence for personal financial planning. To mark the occasion, the Board recently conducted a survey of 1,002 Americans to gauge their opinions regarding the economy, financial regulation, and their own personal financial situations.

Americans are keeping their optimism in check and preparing for a long slow return to growth, according the poll:

• Nearly two out of three Americans (65 percent) are more concerned about their finances today than they were at the beginning of the financial crisis two years ago.
• A bit more than a third of Americans (37 percent) expect to see their personal finances improve in the next six months, versus less than half (46 percent) who expect to hold onto what they currently have, and 16 percent who expect to lose money.
• 80 percent of Americans say that Congress and regulators have not done enough “to deal with the financial market problems and their impact on American investors.”
• A bright spot in the findings: 44 percent of Americans expect the U.S. economy to improve in the next six months, while only 28 percent expect things to get worse. A smaller group (22 percent) anticipates no change in the economy.
• When asked to describe how they feel about their personal finances, the #1 response from Americans was “cautious” (33 percent), followed by “calm” (26 percent), “concerned” (25 percent) and “hopeful” (25 percent). (Multiple responses were permitted to this question.)
• Interestingly, ethnicity seems to bear on the perception of the prospects for the economy, with just 38 percent of whites expecting the economy to improve, compared to 51 percent of Hispanics and 74 percent of African Americans.

The survey found the following about Americans’ attitudes toward financial planners:

• More than two out of five Americans (43 percent) think financial planners are now “more important in the last two years since the start of the financial crisis,” compared to about a third (36 percent) who see no change, and 14 percent who now see planners as being “less important.”
• Overall use of financial planners by Americans has remained almost unchanged during the first two years of the U.S. financial crisis – starting at 29 percent compared to 28 percent today.
• Of those who have started using a financial planner since the start of the financial crisis, nearly a third (31 percent) say they have done so because “I felt like I needed more financial guidance during these difficult times for investors.” A bigger percentage of those in this group (44 percent) said they have started using a financial planner during the last two years for reasons “unrelated to the financial crisis.”

For some reason, there was one question that asked respondents to describe the economy as an animal. The answers were actually quite interesting and revealing: they tend towards slow, lumbering animals like sloths, bears, turtles, and elephants, while few choose the iconic symbol of confidence, the bull.

Not sure what all this tells us beyond what we already know, but I thought it was interesting nonetheless.

Have a great week!

What's in the Financial Reform Agreement?

After an all-night negotiating session, a special committee of Senators and House Members reached agreement early Friday morning on a financial reform bill. The House and Senate still have to approve it, of course, but it is likely to become law. This is important stuff—President Obama calls it the biggest change in financial regulation since the Great Depression—and while it is not perfect by any stretch, I do believe the 21^st Century financial landscape requires such an overhaul. Here are the key features of the agreement:

#1: The Bureau of Consumer Financial Protection. This new consumer agency answering to the Federal Reserve would supervise mortgages, credit cards, student loans and the banks, credit unions and private lenders that issue them. Institutions holding less than $10 million in assets wouldn’t be regulated by the BCFP – but they would have to follow its rules. The BCFP would aim to make these products easier to comprehend for consumers and crack down on any possible deceptive practices.^1,2

#2: See your credit score for free. If you are turned down for a mortgage or a loan, the new reforms would give you the power to see the credit score supplied to your lender. Right now, you can request three free credit reports each year but you can’t see your actual score.^1,2

#3: Tougher rules for mortgage lenders. These rules should have come into play years ago, of course, but better late than never. Mortgage lenders would need to verify the assets and income of borrowers, thwarting any surreptitious comeback for “liar loans”. Loan officers and mortgage brokers would not be able to receive bonuses for guiding you into this or that loan. Borrowers with ARMs and other types of complex home loans could not be hit with prepayment penalties should they want or need to pay off a mortgage before the end of its term.^1,2

#4: Retail minimums for the use of credit cards. Score one for retailers, who don’t want to see people make $2 credit card purchases when the swipe fee alone cancels out the revenue. Under the new legislation, stores could set minimums for credit card use. The minimum transaction level could be as high as $10 if a store chooses; the Federal Reserve could raise that $10 limit on the minimum with time.^1,2

Alternately, stores could offer consumers discounts if they pay for items with cash or debit cards. (They wouldn’t be able to vary the discounts for different debit cards.)²

Additionally, the proposed reforms could allow colleges and universities and the U.S. government to set maximums for credit card transactions.²

#5: Brokers could be held to a fiduciary standard. This is an important one for me. Under the new reforms, the Securities and Exchange Commission now has the chance to hold brokers to the same fiduciary standard common to registered investment advisor firms such as ours. What that means is that brokers would have to put a client’s best interest first and not simply recommend a “suitable” investment to a client. That new standard may or may not come into play, however; the SEC is undertaking a six-month study to see if such a rule would amount to regulatory overlap or not.³

#6: The “Volcker Rule” would be put into play. This is the rule that would prevent banks from trading with their own money. It would kick in with small concessions. While the reforms would halt most proprietary trading by banks, some limited investment would be permitted – they could provide up to 3% of a fund’s equity, and invest up to 3% of Tier 1 capital in hedge or private equity funds.⁴

The big banks got another key concession from Congress: they don’t have to get rid of their swaps-trading desks (some legislators had contended that this decision would drive such trading to foreign markets). They can still be involved in foreign-exchange and interest-rate swaps dealing.⁵

#7: An Office of Credit Ratings would appear. It would oversee the actions of Moody's, Standard and Poor's and other big names, and one of its objectives would be to flag potential conflicts of interest that could influence ratings judgements.¹

#8: The SEC would no longer regulate equity-indexed annuities. This is one area where I believe the legislators got it wrong. The promotion and sale of these annuity contracts has generated much flak in recent years. Interestingly, they would be overseen by state insurance regulators if the reform bill passes, and treated strictly as insurance products.²

Now, what about Fannie Mae and Freddie Mac? Good question. Nothing made it into the final reform bill to address that dilemma. Some analysts expect another bill will emerge in 2011 to propose their restructuring or elimination.⁵

Have a great week!

–Andy

A Stomach-Turning Drop

Last Thursday’s fast and furious drop in the stock market appears to have been influenced—at least in part—by a typographical error. The Dow plunged 1,000 points in five minutes before it partially recovered. A number of trades had to be cancelled because of errors related to technology problems.

Events such as this emphasize the futility of trying to predict the short-term direction of the market. We also shouldn’t read too much into this regarding where we’re going. As I have said many times, we’re entering a new economic era. We don’t know exactly what it will look like or how long it will take to get there, and many factors will contribute to the process. We just have to position ourselves as advantageously as we can, and let the process run its course.

Have a great week!

Genghis Khan: He Was No Huey Long

I received quite a few interesting and insightful responses to last week’s question regarding the reasons why people do or do not seek advice from financial advisors.

It is clear that each person has his or her own reasons for doing what they do, and they are as varied as the people who hold them. I’d like to quote a few here, but unfortunately I can’t. The SEC has very strict regulations regarding the use of direct quotes from clients and even non-clients. Therefore, the numerous very thoughtful responses I received shall remain private.

On a completely different note, I recently listened to two biographical audiobooks: Genghis Kahn and the Making of the Modern World by Jack Weatherford and Kingfish: The Reign of Huey P. Long by Richard D. White, Jr.

Wow! What fascinating and extraordinary men. I didn’t deliberately choose these two books in succession, but having listened to them in order, it’s only natural to compare and contrast the two leaders.

Genghis Khan (pronounced “JEN-gis” as opposed to “GEN-jis” as I had previously thought) was a reluctant conqueror, not beginning to amass his empire until he was over fifty. By the time he died peacefully in 1227, he ruled an area as large as all of North America and half of South America. His influence extended from China through the Middle East and all the way to Eastern Europe. His sons extended the Mongol Empire into the largest contiguous empire in history.

He and his “Mongol hordes” have developed a reputation in recent centuries as primitive barbarians who conquered more-advanced cultures through terror and violence. Indeed, the Mongols were extremely limited in terms of education, they presented a frightful appearance to their intended victims, and like all conquerors, they gained territory through violence on the battlefield. But the standards of the Middle Ages, theirs was a remarkably egalitarian society, and the Khan was a remarkably magnanimous ruler. He allowed conquered societies to retain their own cultures, and wherever he found new and useful ideas or inventions, he spread them to other parts of his realm, so all could benefit from them.

The Khan (born with the name Temujin) was by no means a saint. He murdered his own half-brother when he was still a boy, an act that presaged a violent adult life. But, in a twist that may seem hard to accept in such a violent individual, he also was by nature a fair man. Whenever he needed to make a major decision, he would call a Kurultai, a mass assembly of his people. On the vast Mongolian plain where the population was widely dispersed, people often would have to travel many days to reach the site of the Kurultai. In fact, the very presence of a large assembly indicated their support for the idea at hand; if the people stayed away, the clear message was “no.”

In many ways, I found myself liking, admiring and respecting Genghis Khan, especially in comparison to other rulers of his era. I can’t say the same for Huey Long, the ruthless, power-hungry Governor of Louisiana during the Great Depression. I won’t take time this week to talk about Huey; maybe next time.

Have a great week!