Burton Malkiel on 2012

As I review the performance of various asset classes in 2011, it is rather clear that the investment markets continue to struggle with the effects of the global financial crisis. There are very few asset classes that performed will last year.

I have read several books on the history of economic crises and the impact such crises have on the financial markets. The correlation between asset classes converges and there are often few places for investors to hide. Unfortunately, last year was no exception to this phenomenon.

Most investors have undoubtedly grown weary of watching their portfolios languish. The past several years, starting in the fall of 2007, have not been kind to investors.

I know from my self-directed reading that eventually crises end and asset classes begin to follow a more normal pattern of returns. However, the current economic crisis in Europe (and the United States) is rather acute and the deleveraging process that must precede market recovery will quite likely take longer than most expected and hoped.

The fundamentals of investing have not changed: proper asset allocation, diversification, low costs and systematic rebalancing. You might find this article by Professor Burton Malkiel in The Wall Street Journal reassuring, "Where to Put Your Money in 2012." Professor Malkiel and Richard Ellis co-authored The Elements of Investing, which I highly recommend.

Measuring Investor Risk

I have used FinaMetrica's investor risk profile for several years to attempt to assess clients' ability to accept risk. FinaMetrica's found, Geoff Davey, was recently featured in an online interview I viewed. Davey identified three distinct forms of risk that investors confront.

Required risk measures the extent to which investors must expose themselves to market volatility and losses in effort to receive the returns they need to achieve their goals. We can use standard deviation as a means of measuring this risk.

Risk capacity refers to the investors' ability to accept losses. If an investor has a $10 million portfolio, a $50,000 loss is not a big deal. The loss is just ½ of 1%. An investor with a $500,000 portfolio would have lost 10%. A very big deal.

Risk tolerance is a psychological construct. It's a personality trait. It's what FinaMetrica measures with their profile.

When I write an investment policy statement for a client, I refer to all three kinds or risk.

Fund Stars Plummet

I am always looking for evidence to support my belief that it is very difficult, probably impossible, to find mutual fund managers who will outperform their benchmark. It is not difficult to find managers who have beat the market in the past. That information is readily available through Morningstar.

The investment industry and the financial media will often celebrate fund managers who have outperformed the market for an extended period. So, I found it noteworthy that The Oregonian identified five mutual fund managers who have come upon hard times. As of the December 6, 2011, the date of the article:

Bruce Berkowitz was Morningstar's Domestic Fund Manager of the Year, 2009, and Stock Fund Manager of the Decade (2000-2009). His Fairholme Fund is down 29%. The Standard & Poor's 500 index is down 1%.

Michael Hasenstab was the Morningstar Fixed Income Manager of the Year in 2010. His Templeton Global Bond fund has lost 2.4% this year.

Bill Gross was the Morningstar Fixed Income Manager of the Decade (2000-2009). Gross runs the largest mutual fund in the world, the Pimco Total Return fund. The fund has gained 2% this year, but trails 91% of its peers.

David Herro was Morningstar's the International Stock Fund Manger of the Decade (2000-2009). His Oakmark International fund is down nearly 13% this year and is in the bottom 25% of its category.

Even the most accomplished fund investors can get derailed. Most eventually do.

The Financial Truth

Today marks the 70th anniversary of the bombing of Pearl Harbor. It was a day that, as President Roosevelt said, would live in infamy. The attack drew the United States into World War II. The war brought out the best in this country. We were galvanized, emboldened and determined to preserve the values upon which this nation was founded.

We are facing yet another great challenge, although not one that will be fought in battle fields, in the skies or on the seas. It is a struggle in which the majority of Americans are finding themselves in trouble financially. Some are in truly desperate financial straits. This short video conveys the seriousness of the matter more powerfully than I can.

Financial Truth

Please watch it and then encourage those around you to save more, spend less and borrow less.

90, the new 70

I read recently that, according to the Census Bureau and the National Institute of Aging, the number of people in the US who are age 90 or older has nearly tripled since 1980. This is pretty remarkable. At the turn of the last century, life expectancy in this country was 47 years. While that figure is skewed by much higher infant mortality, people were living much shorter lives than they are today.

Keep in mind that life expectancy is the average. Half of the people will reach that age. The other half won't make it. If you are in good health, eat well, exercise and avoid smoking and heavy drinking, you are likely to live beyond life expectancy.

If you are curious about how long you will live, you might try the calculator at Living to 100 http://www.livingto100.com/. I did and I learned that I better plan to live to 100. (All of my grandparents lived to age 90. One lived to 95 and another lived to 98. So, I have a decent shot at making 100.)

When I give clients a retirement planning questionnaire, they often put down an age for life expectancy that they relate to their parents and/or grandparents. The problem is that they are likely to live longer than the generations that preceded them.

A good financial planner will model at least 5-10 years beyond current life expectancy. If the your goal is to live comfortably for as long as you live (i.e. to not run out of money), then you should make sure you have a safety margin for those extra years.

Happy Thanksgiving!

This Time is Different

If you are interested in placing the current global economic crisis in perspective, I recommend reading This Time is Different by Ken Roggoff and Carmen Reinhart. I read it while I was in Nepal and it helped me understand the history of these crises. We've been careening from crisis to crisis for literally hundreds of years. The current crisis is rather acute and we will not emerge from it any time soon.

I watched the republican presidential debate last night. I was not inspired. I would really like to see our leaders, in both parties, begin having a candid conversation with the American people about how we can solve our economic problems ... unemployment, national debt, budget deficit.

The solution is really pretty straightforward. But it is not easy and not appealing. So, no one really wants to talk about it. The solution is really pretty straightforward. But it is not easy and not appealing. So, no one really wants to talk about it. I'm sure they calculate that, if they tell us the truth, they won't stand a chance of getting elected.

Here's what has to happen:

1. We need reduce our expenses AND

2. We need to increase our revenue.

3. We may need to sell some of our assets to pay down our debt

Simple. This is what I advise clients to do if they are struggling with debt or negative cash flow. Our government is no different.

By the way, the title of the book is a tease. This time is not different.

Confidence has its Limits

A prospective client sent me an article that ran in The New York Times on October 19, 2011.

It was written by Daniel Kahneman who is an emeritus professor at Princeton and winner of the 2002 Nobel Prize in Economics. He is a leader in the area of behavior economics.

The article, "Don't Blink! The Hazards of Confidence" is quite interesting.

Investors who believe they are able to beat the market would benefit from considering Kahneman's message.