October 10, 2008

Money & More Pain?

Dear Friends & Fellow Investors

Wow…finally the trading week is over, time to exhale if you haven’t done so yet.

Last week, I talked about money & pain. Where do we stand today after the Dow having its worst week ever in history? Have we reached our pain threshold yet?

These are clearly difficult financial times, the effects of which will impact many aspects of our lives in the coming years. It may change our perception of the value of money and our relationship towards money and investing as well; at least I hope it will because the excesses and the horrible effects of leverage have unearthed the dark side of free market capitalism. The current downward spiral is a necessary de-leveraging process and going back to the traditional way of investing may not be such a bad thing after all. Less potential (illusive) reward but also much less risk.Earlier this week, the Vanguard Group founder John Bogle reminded us of the “age-related” retirement (investment) formula, in which your bond position equals your age. This may be an oversimplification for the more sophisticated investor, but I personally like simple plans - easy to understand and easy to apply. Let’s look at some numbers…

Say you’re 50 years old: Based on John Bogle’s approach, you should invest 50% of your assets in bonds. If Bonds are too complex, invest those 50% in income producing assets which are guaranteed i.e. money market, CDs, savings accounts etc. At the beginning of 2008 you could get CDs at around 4.5%, let’s use those as the benchmark. If you had $200,000 to invest and you put half in CDs generating 4.5%, your year-to-date value of $100,000 safely invested would be $103,489.04 today and $104,500 at year-end. The other half invested in the market (S&P500) would be worth only $61,239.75 today, reflecting the over 38% decline thus far - and we don’t know where we will be at the end of 2008…

But since you’re hedging your bets, your overall (paper) loss is (only) about $35,000 or about 17.5% so far – still painful, but probably more manageable. Granted, this is an over-simplification but it illustrates the risk/reward principle nicely; and asset allocation does make sense. Obviously the insane gyrations of the current market may only occur once every generation; but if you are not comfortable with risk and particularly if you’re approaching retirement age, you should simply leave some of those “illusive returns” on the table and just be happy with a leaner but much safer investment portfolio.Now, to further limit the downside on an already painful investment portfolio, I would again make the case to invest in the lowest cost index tracking funds such as Vanguard 500 or SPY Exchange Traded Funds. The cost of investing in Mutual Funds on average takes 1-2% off your returns in profitable years and adds 1-2% to your loss in declining years. These costs are avoidable since you should not pay some sleek fund managers trying to chase “illusive returns” by attempting to outperform the market. The majority of them don’t, you can save your money.

With regard to the markets, it is hard to say whether we have reached a bottom, but it sure feels a lot like one (so we all wish). Whatever lies ahead, it is important to remember that the basic concepts of asset allocation and money management are critical in any market and any investor can use asset allocation in its most basic form to mitigate some risk. I’ll gladly send you a copy of this basic asset allocation tool and you can assess what your personal situation would look like based on the latest numbers.

Please send me an email if you have any questions:

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