Stress Test

Now is the time to look at what your future plans and calculate a strategy for investment success. You are where you are because of the decisions you’ve made in the past. You can decide whether you want to panic and sell into the carnage and lose a major chunk of your investment dollars or you can decide to hang on.

It’s not like we haven’t seen wealth destruction in the past. The key is to learn from it.

It is too late to say that you should have been better prepared. However, that doesn’t mean that you cannot learn from this market meltdown and get better in the future.

Portfolios must be monitored, and changes should be made when needed. You must rebalance your portfolios at least once a year, so you can buy on the dips. The buy and hold methodology is dead. Markets change and so should your investments. Set it and forget it is not good enough.

You are where you are now. So, how do you get out of this mess?

Take a look at what you own. Do the stocks you own have a high probability of success in the future? Make sure you have good quality positions. If possible, keep buying more. Get rid of bad positions if necessary and add to the good ones. In order to survive this brutality, you need to own best-of-breed stocks. You have to look at your positions and ask yourself if they are the top companies to own. It isn’t time to speculate on what companies MIGHT do well down the road.

If you own mutual funds, you have more homework to do. You’ve got to see what’s under the hood. Does the fund own quality positions? Are they buying best-of-breed?

With the major markets down 30% or more, your best strategy is to look ahead. Ask yourself if you have the kind of investments that will make money down the road. Although it should go without saying, the flight to quality is imperative now.

Of course, it always should be.

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It’s time to buy!

The rule says to buy stocks low and sell high.

The reason there are rules for investing is simple: you always have to keep your emotions in check.

This week, the rapid spread of coronavirus and lack of containment in countries outside of China rocked global markets. All three of the major indices fell into a correction in a matter of six days. The Dow logged its worst week since early 2008 and the S&P 500 Index plunged by more than 11% into correction territory. Also, government bond yields have fallen to record lows.

I’m not saying that you deploy all of your cash position into the markets, however, you need to invest some of your available cash into positions that show promise over the next 12-18 months. This correction erased gains of almost all stocks equally with no regard to individual stock outlooks.

Therefore, you are now able to pick up some high-quality stocks at discounted prices.

Of course, you need to have money available to buy stocks when they go on sale. This is why it is important to rebalance your portfolio and take some profits off the table when the market reaches new highs. If you didn’t take some profits at the end of 2019, you (or your current financial advisor) are not paying attention to your account.

Again, you can’t buy stocks on sale if you don’t have the money.

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Pull Up Your Shorts!

Stocks rose sharply in volatile trading on Wednesday as surges in retail and energy shares helped Wall Street regain most of the steep losses as the market breached bear territory.

As of Christmas Day, the Dow and S&P 500 was down almost 15% for the month, with the Nasdaq down a little more than that. It’s been an awful month in a terrible quarter, featuring the worst Christmas Eve trading session ever.

In retrospect, the last time valuations were around current levels certainly proved a great chance to get in. The S&P 500 has handed investors a 56 percent return since the start of the final quarter of 2013, a period that includes the near 15 percent tumble in the index this month. And earnings growth has been much stronger this year than earlier this decade, a trend that many see continuing thanks to solid U.S. job and consumption growth.

A market correction (a drop of 10 percent or more) is often a leading indicator of the possibility of a near-term recession as investors sniff out a potential slowdown in consumer and business spending that could hurt corporate profits.

But by several key measures, the economy is in its best shape in years, posting its strongest six-month stretch since 2015 and poised to reach 3 percent growth this year for the first time since 2005. The 3.7 percent unemployment rate marks a half-century low and heralds faster wage growth for American workers. And retail sales have been robust. That’s important because consumer spending makes up a majority of all economic activity.

Some analysts bumped their projections on some of the more notable tech stocks which, in turn, made many investors cover at least some of their shorts. It’s hard to hold on to bets against the market when there is even a hint of good news.

I did close out part of my hedges at a nice profit into the carnage which freed up some money to add to some of my solid positions that pay steady dividends. I already took care of tax-loss selling and am prepared to hold a nice cash position for the foreseeable future. If the market rallies big into the new year, I am ready to put on more hedging.

One thing I always look for in rallies is to see what stocks are up with the market and which ones are not. If a stock isn’t going up with the market, I want to steer clear of it. If a stock goes down more than the market when the market falls and rises less than the market when it goes up, it send a clear signal that it may not be a good position to own. The ones that are rebounding along with the market are the ones I want to keep an eye on for buying when they go back on sale.

While some economists see elevated danger of an impending recession in the U.S., indicators ranging from the job market to manufacturing PMIs still suggest solid growth. However, we have to remember that we never really feel the pain of a recession until we are already knee deep in it!

Whether we become submerged in a full-blown bear market or the bulls find a way to actually maintain a sustained rally is yet to be seen. Either way, I expect continued volatility in the markets. In fact, sometimes the fastest and largest rallies can be seen during a bear market. That’s why it pays so well to be flexible and make smart moves when opportunities present themselves. These minor adjustments can make a huge difference in your long-term portfolio.

For now, just understand that short sellers must follow discipline and unleash their hold on the downside when there is any hint of positive news in the markets. However, it doesn’t mean that we give up being cautious (which includes holding a strong cash position) and maintain well-balanced portfolios. React to market movements in the context of your goals. Identify when you need the money that you have invested, how much you need and how important it is that you have that money.

However, keep in mind that the markets are forward-looking instruments and if they are giving us warning signs of a recession in the future, we shouldn’t ignore the message…

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We Need Capitulation

After a 10 year runup in stocks, everyone wants to be the correct prognosticator of the inevitable stock market crash.

It just can’t happen yet.

I hear talking heads of large fund companies pounding the table on buying stocks on the dips. They say that the fundamentals of the companies they own in their portfolios are sound. However, those who think that the economy is so strong that it can handle any number of interest rate hikes are just fooling themselves.

“Stocks are on sale” they proclaim.

That was the mantra for the last 10 years and they filled their coffers with tons of cash and built robust portfolios, albeit while most still trailed the major stock indexes.

However, things ARE different this time.

Despite two 10% corrections this year so far, investors have not yet realized the difference between buying on the dips in a bull market and the inevitable signs of a bear market. With no clarity of 2019, it is really hard to believe that buying the dips will be rewarding. The rules say to buy low – in a bull market. However, buying low in a bear market can wipe you out because stocks keep going lower.

During a bull market, prices trade above the long-term moving average. However, when the trend changes to a “bear market” prices trade below that moving average. Currently the “bull market” is still intact as prices remain above the long-term moving average. However, evidence continues to mount that support is at risk of giving way.

At this point, my mantra is that downside risk dwarfs upside reward.

In fact, I would be using any strength in the market to sell any laggards and I’m also not overweight in my stock allocations. Anything I bought that I want to hold for the long-term but overpaid for, I am selling for tax losses and looking to buy cheaper.

It’s funny because many of the stocks that I’d like to own are still not on sale in my viewpoint. While I do like to add to positions on weakness, I realize that being aggressively exposed to the financial markets provides less reward in this environment.

One of the things that frightens me most is the reality that the earnings growth touted by the pundits was indeed derived from tax cuts but also through the extensive use of share buybacks. While the mainstream media, and the Administration, initially rushed to claim that tax cuts would lead to surging economic growth, wages, and employment, such has yet to be the case. Instead, companies have used their tax windfall to repurchase shares instead.

Earnings growth not supported by strength is revenues and innovation of new products and services just isn’t healthy for the economy. This is an important point when you realize only a small percentage of total reported EPS growth actually came from increased revenues. While stock buybacks, corporate tax cuts, and debt-issuance can create an illusion of profitability in the short-term, the lack of revenue growth suggests a much weaker economic environment over the long-term.

In order to get excited about putting money to work in this environment, we need to see capitulation. The kind of selling that happens when everybody wants to throw in the towel and sell stocks. The kind of selling that gets rid of the weak holders of stocks.

Just remember, when the pundits tell you to sell, it is too late. All of the smart money has left which leaves you holding the bag.

Furthermore, since both fiscal and monetary policy tools were employed during the economic boom, it will only ensure the next recessionary drag will likely be larger, and last longer, than most expect.

Caution is the order of the day. Make sure you’re not the one holding the bag of over-weighted stock positions.

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Money Clinic: Garbage-In/Garbage-Out

The phrase “Garbage-in/Garbage-Out” (GIGO) is commonly used to describe failures in human decision-making due to faulty, incomplete, or imprecise data. While this expression predates the computer age, the term can still be applied. Some things just never change.

In the world of financial planning and investments, the reality is that we cannot control the future outcomes in the macroeconomic environment. The most we can do is make the best day to day decisions that we can make in the present to influence the probability of positive future outcomes.

The simplest way to do this is to avoid making stupid money mistakes. You must BELIEVE that you can be financially successful too. Also, you need to get a better understanding of how and why money works and which tools to use for specific jobs. You must become more cost and tax efficient with your financial tools and assets. Finally, you must take ACTION and maintain your focus on PROVEN PRINCIPLES that actually work.

One of the biggest mistakes that I have seen people make is to compare their portfolio against a traditional benchmark like the S&P 500. It just doesn’t make sense to try to keep up with an unmanaged, no-cost index that has no relevance to your personal investment objectives. The best thing you can do for your portfolio is to quit benchmarking it against a random market index that has absolutely nothing to do with your goals, risk tolerance or time horizon.

Since we often look at past performance to estimate future returns (something that every investment prospectus warns against), we end up making illogical forecasts that have very little chance of turning in our favor. Most people end up taking on more risk than is necessary or delay their planning which then makes them take more risk in order to reach their goals.

The only benchmark that should matter to you is the annual return that is specifically required to obtain your savings or retirement goal in the future.

I hate when the television charlatans throw-out meaningless advice that only confuses people sincerely trying to do better with their money, especially when the pundits didn’t accumulate their wealth by investing.

For example, Suze Orman (touted as America’s most recognized personal finance expert) spews garbage out of her mouth professing that if a 25-year-old puts $100 into a Roth IRA each month, they could have $1 million by retirement.

First of all, many young people are struggling with finding a good-paying job or severely burdened with college loans to be able to consistently save money for something 40+ years away!

Furthermore, it not that her math is wrong, it just requires the 25-year old to achieve an 11% or so annual rate of return (adjusting for inflation) every single year for the next 40-years! Despite the bullish advance from the 2009 lows, the compounded annual total return for the last 18-years remains below 3%! Also, once the impact of inflation and taxes are included, the outcome becomes substantially worse.

She also fails to mention that WHEN you start your investing, and more importantly WHEN and HOW you make withdrawals, has the greatest impact on your future results. We don’t automatically get to start at some theoretical low point and begin making withdrawals in a peak market that never declines!

Finally, why in the world would anyone ever listen to somebody that didn’t make their fortune by investing? Ms. Orman has been touting her “expert” financial advice for 35 years. Do you really think that Suze made her investment fortune by the time she was 32?

This is a prime example of GIGO. It will derail your best-laid plans if you base your decisions on that garbage. Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating future returns, retirement projections are artificially inflated which makes you erroneously estimate the required saving amounts you need to make today. Is it any wonder that many people are woefully underfunded in retirement?

In the real world, the primary focus of financial planning is to create multiple options that can give you “choices” for the most advantageous use of your money based on the circumstances at the time you need it or ultimately transfer it to your heirs. Where you are in life and where you want to be in the future ultimately dictate the money decisions you should make.

The wealthiest 1% of the population calculate the highest and best use of specific assets and then make a decision to buy or sell based on that calculation.

Therefore, when trying to decide what financial products make sense to use in your financial plan, you just need to copy the characteristics that the wealthiest 1% of the population use in their plans and apply them to your own situation!

The features of the products you purchase should have characteristics that make it easier to reach your goals. You want to have products that you can systematically contribute money into but still have money available when you need it. You need to minimize taxes on those contributions whenever possible as well as minimize taxes on the distributions of your accounts. Your money sources should be protected from loss due to death or disability. You should strive to earn a superior return on your money while minimizing potential losses. Finally, you need to have flexibility to make changes during your lifetime.

In other words, the purpose of the money dictates where you should put it. Any financial decision you make must be considered thoroughly because of the impact that it has on your whole financial picture and how it may affect other assets you own. When building wealth, you must put every dollar towards its greatest use and optimize the performance of each financial asset that you own.

Recycle critical inputs

The characteristics of the ideal financial plan can continuously be recycled during any phase of your life. If something happens in your life and you get off-track, you can simply recycle the successful concepts and characteristics to get back on course.

You can study other financially successful people and learn what they have done to become wealthy. Remember, there is no specific dollar amount that makes a person wealthy. It is a mindset and a lifestyle choice.

While the media “experts” often make everything seem complicated, it doesn’t need to be that way. It is imperative to understand the rules of the game before you get in the game because the system isn’t set up specifically for your benefit. The system is set up by corporations whose number one priority is to maximize profits for the shareholders, not for you.

When you are looking for answers, consider the source. You should be looking for resources that talk about solutions to crucial investment issues like: how to increase savings rates when markets don’t give generous returns, why to factor-in future inflation rates when planning for retirement, where to find tax-favored investments that also generate tax-free withdrawals, how to create multiple sources of retirement income so you are not held hostage by portfolio drawdowns, and how to realistically forecast future returns based on variable rates and not compound rates of return.

Are these tough questions to ask? Yes, indeed. But the answers to these questions and any other inquiries that you have about making decisions that affect YOUR goals and objectives are the most important—not the random bits and morsels handed out by the media.

Sometimes, you can learn from your mistakes and get better. However, it is easier to learn from other people’s mistakes. There is enough information available to you regardless of your present means. You can easily develop a set of rules or guidelines that other successful people have used and apply them to your own situation.

It all starts with the realization that the purpose of money management is to manage the environment that you CAN control and give yourself options to make money in any economic environment as well as to have money available whenever you need it.

If you continue to get smarter about money, you will process less garbage in your head and you will increase your odds of becoming financially successful.

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