Sushi Money

The market has made amazing gains over the past two days, and posts the biggest 2-day gain in five years. Pretty amazing numbers. We’ve been here before, but are we staying for awhile or not? And how many people took money off the table over the past few weeks? No surprise there- with all the financial turmoil many of us have become a little more conservative these last few months. But as I was looking over the market yesterday morning it just looked ripe with opportunity, hence yesterday’s post. Now the financial pundits will really be out in force debating the merit of this weeks market gains.

Through last week the Dow was down almost 10% from it’s high a few months earlier. The Wall Street Journal declared a correction a few days ago, looking ahead at the possibility of another 10% down indicating a bear market had returned. But after the last two days, are we out of the woods, and is the Bear still in there hiding? Sure looks like it, but that financial Bear is a wily creature. A lot of smarter folks than I expect all the negative news to have significantly more impact to the markets than we have seen lately. And a possible recession, meaning that many folks think we’re just not there yet. We don’t have that “feel-good” factor going! With the subprime and mortgage mess reaching a peak in mid-2008, there’s still lots of negative news to go around.

But you know what? I think there’s a whole lot of fund managers and investment firms competing to show some healthy gains for investors. With the hedge fund derivative losses this year I suspect a lot of smart folks are re-examining just what risk means. Maybe some of the good quality stocks are pretty decent investments after all. Maybe we don’t have to go looking for the “next best thing” or crazy combinations of risk in order to show decent returns for investors. Maybe dividends and solid year-over-year growth is not a bad place to be over time. Maybe a lot of folks will return to the fundamentals on stocks.

Then again maybe fear will continue to run amok and the markets will crash. Who the heck really knows where the market’s going? Certainly not me, but I did put a chunk of money in some key areas yesterday that look even better today. Looking ahead I see the Fed cutting rates a quarter point, the holidays making us all feel pretty good, and the election cycle really kicking in for 2008. Maybe we’ll even make more progress overseas, and start bringing some troops home. Some folks see market forecasts intertwined with the election cycle… and a Democrat in the White House next time. I don’t know what that means, except perhaps higher taxes on everything.

Something I do know…. markets go up and down, and change is the only certainty. It’s just the name of the game… a game in which I try to keep madness and the risk of emotions out of the way. Ten years from now my only memory of this day will be this post, if it still exists. Looking back ten years ago, I have no idea what I was doing…. Oh wait! Yes I do remember… I was having too much fun and not saving or investing nearly enough! Sometimes I wasn’t having any fun, and still not saving or investing enough. Now I know better… just keep plunking money in the pot, and try not to get too excited whether the market’s up or down. But up certainly is better than down isn’t it?!

     Last Friday was one of those Ouch! kind of days… with the Dow losing over 360 points right about on the anniversay of Black Monday in 1987.   Not that 2007 had anything to do with 1987… just a coincidence to be sure.  Yesterday had more to do with rising economic concerns, options expiration and the last quarter of the calendar year.  But do you remember that day in 1987?   I talked about it here when looking at emotions and investing.  For a day that many still talk about 20 years later, guess what?  The market went up over the next few months and many people did okay that year.  Who really got hurt?  Mostly it was traders who had a lot of money as risk, as well as margin players.  When you borrow a ton of money…. in other words, use leverage to prop up your investments, then when the market volatility becomes extreme you risk losing a lot of money, and yes- making a lot of money.  But it’s not a practical approach to investing for most of us. 

     Personally, I want to be positioned so that I don’t really care over the long-term.  Of course I care how my investments are doing over time, but really- I don’t want to worry about my portfolio.  After putting your asset allocation together in a well diversified portfolio, you just let it do its thing.  If it really bothers you when the market goes down, then that should tell you something’s out of whack.  Either you are investing too much contrary to your personal level of risk tolerance, or maybe you’re worrying unnecessarily for no rational reason and watching the market too closely.  It’s easy to do, but over time it helps to gain a sense of detachment and maintain that “big picture” for where you want to be in 10-20 years.  

     If you’re close to retirement, it’s very important to maintain a diversified portfolio.  For so many of us, we invest in what we think we know.  A lot of folks invest in company stock in their 401(k).  Not a bad idea at first, and many companies require it.  But if you’re close to retirement, why put all your eggs in one basket?  A lot of folks at Enron really got hurt doing that. 

     What does diversification do for you?  It simply reduces the risk of investing, especially for individual stocks.  Mutual funds offer inherent diversification at a lower cost over time.   True diversificiation involves measuring correlation coefficients and host of other stuff.  But essentially, you want to invest in securities whose returns don’t move in a similar fashion over time.    There’s a ton of info on the web about building a diversified portfolio.  If you’re concerned, talk with your planner or advisor and review your situation.  

     I think it’s kind of like our garden in the spring.  We plant many different seeds and ”starts” for a season of growth for a bunch of different vegetables and flowers.  We don’t plant just one seed or little plant because there’s a lot of risk out there.  Temperature, water, insects, soil fertility, bunny rabbits!  If we plant just one of something we risk that it may not grow very well or produced the return we hope for.  At worst case the little plant withers and dies.  

Investing is a lot like a garden… you want a bunch of stuff in there early in the season to have a robust mix later at harvest time.  

     And for our investments, the growing season is not measured in months, but rather years!   Every time we save and invest, we are planting seeds for a new season of growth.  We may harvest a little of that at a time in future years, but unlike the plants in our backyard, with time and compounding, our investment garden will just keep growing and growing.

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     We’re back to headline grabbers: “Stock’s Plunge…”  Maybe there’s only so many adjectives you can use to describe the stock market.  Do you think major media writers have a short list of words that they use on a monthly basis, and they cross them off on different days?   Seriously there are only so many ways to describe the ups and downs of the indexes.  Lately we’ve seen greater volatility.  One day we’re up a hundred points, and the next day back down.  I read somewhere that daytraders love this kind of a market… they make money going both ways.   But is the tagline “Stock’s Plunge…” really very helpful to the average investor?   Honestly, with the Dow down over 200 points at midday today, that’s still just over 1.5% down for the index!  The same thing for the S&P 500.  

     Here’s my question:  How can we not expect the market indexes to go up and down each day?  That’s what the market does… it can’t go straight up, at least very long.   And it doesn’t normally go straight down… at least very long.  Sometimes the trend goes up and down for longer periods, but the market is a place where people make, and lose, money.  The volatility and market swings are due to large financial institutions… mutual funds, banks, brokerages, pension funds, and a little bit of the retail investor, buying and selling securities.  As the market valuations increase through the years, we will see larger point swings up and down.  But on a daily basis do the percentage changes really mean anything?  Here’s a pretty helpful assessment from StockCharts.com while examining Dow Theory:

Daily Fluctuations

“Daily fluctuations, while important when viewed as a group, can be dangerous and unreliable individually. Due to the randomness of the movements from day to day, the forecasting value of daily fluctuations is limited at best. At worst, too much emphasis on daily fluctuation will lead to forecasting errors and possibly losses. Getting too caught up in the movement of one or two days can lead to hasty decisions that are based on emotion. It is vitally important to keep the whole picture in mind when analyzing daily price movements. Think of the pieces of a puzzle. Individually, a few pieces are meaningless, yet at the same time they are essential to complete the picture. Daily price movements are important, but only when grouped with other days to form a pattern for analysis. Hamilton [William Hamilton - early Dow theorist] did not disregard daily fluctuations, quite to the contrary. The study of daily price action can add valuable insight, but only when taken in context of the larger picture. There is little structure in one, two or even three days’ worth of price action. However, when a series of days is combined, a structure will start to emerge and analysis becomes better grounded.”

     Of course Dow Theory is just one way of looking at the market.  We always hear about not “watching the market” and just letting our investments do their thing over time.  For long-term investors, daily market fluctuations should not be a cause for concern.  Certainly macro-economic factors that come into focus will impact the daily market action over time.    But from a hands-on perspective, it’s fun to watch the market moves.  We feel rewarded and secure when the market goes up… and not very good when it goes down!  Admittedly, I do check the performance of my stocks and funds regularly.  If you’re managing your own investments, it’s important to keep track and evaluate performance and allocations over time.  But it’s very easy to become caught up in the media headlines when the market is simply doing what it’s supposed to.  Whenever I get concerned about the market’s volatility, I try to remember why I’m investing in the first place.  Do you watch your investments closely?  Or just a little?  I’m curious how others manage their investments over time.

     I enjoy reading insights from the “experts” in business and finance.  I may not always agree with them, but I can learn a lot in the process.  Fortune via CNN/Money has a great short interview series called Crisis Counsel where 13 business and financial leaders give us their take on the current market, liquidity issues and what the future may look like.  My favorite is #13… probably because my strategy places me squarely in the camp of the “stupid investors”…   Overall it’s a revealing glimpse into the perspectives of some fascinating people. 

A busy week at home and with classes.  But school’s out for the kids and summer is approaching quickly!  Lots of chores to catch up on taking care of the house as well.  What do you do during the summer months?  We made a list the other night and gave up after sixty task items… ugh!  But you’ve got to start somewhere.  I see painting and weeding in my future, along with lots of grass cutting.  I cut about 4-5 acres every 10 days, and more if it rains a lot.  I actually enjoy it… until about July.  Then I’m ready for a break and fortunately the weather cooperates as the rain slows down and the grass begins to go dormant for the summer.  Watching the markets lately I’m wondering if they too will go “dormant” soon…  returns have been pretty nice so far this year, but as May draws to a close I wouldn’t be surprised to see the markets take a break.  As summer begins many families will be planning ahead for vacations and school in the fall.  The election cycle will pick up steam as we approach fall, and 2008 will be a busy year.  I’m not sure I’m ready for the political media circus, and it’s hard to believe we’re starting again.  But I’ll keep plugging away on saving and investing, and the slow accumulation for our 529 fund.  After Congress made the 529 plan legislation permanent last year, there is almost no reason for a family not to fund a 529 for college education savings.  I started one in 2002, and it has done remarkably well with an average of 16% gains over the past five years.  It helped to have a good “down” year of putting money in the fund early before the market roared back in 2003 as well.   My 6-year old doesn’t know much about money or investing yet, but we’re going to start learning a lot more together this year.  I would love to start a Roth IRA for him at some point as well- if he can place some earnings in an IRA while young, and keep at it through the years, he could be so far ahead of most of us it would be amazing!  I like to think of investing in terms of generations.  Certainly achieving financial security during our lifetime, and for our retirement years is a primary goal, but at some point I would like to accumulate enough to leave a financial legacy.  In what form?  Well, both for charitable purposes as well as family goals.  Wouldn’t it be something to leave enough money to ones heirs that it could continue to grow over decades, providing some assistance for children, grandchildren and even great grandchildren?  I have no illusions of fame or historical significance… but doing something for family in the years ahead would be pretty cool.  But it’s time to focus on the present… tomorrow I’ll get a little class work accomplished… and maybe even cut some grass.  Money and investing is kind of like taking care of the yard to me… the blades of grass simply grow.  Sometimes bare spots appear, and weeds take over.  But we plant more grass seed, and try to minimize the weeds.  With care the blades of grass multiply and continue growing, providing a cool foundation to enjoy over the years.  The grass grows faster at times with good weather and a little rain, and then slower when it’s hot and dry, going dormant to all appearances.  But the roots are there, waiting for better climate… and then zoom! it begins to grow again, sometimes in great leaps.  If we take care of our financial assets, they too will continue growing… sometimes in great leaps, and sometimes slowly, even leaving bare spots at times.  But saving and investing consistently over time will lead to a foundation of greener pastures in the years ahead.

Does the market just keep going up?  The big 13k is close but does it really mean anything?  I don’t follow the technical indicators much, and for me it’s just a number.  Motley Fool expressed it pretty well in a recent article titled “Dow 5,000?” I don’t usually read the MF articles- too many hoops to jump through and it seems like most of their stuff is a sales pitch.  But many of the articles are informative, and I agree with Mr. Zimmerman about being prepared:

“…savvy investors should strive to fix their portfolios while the sun is shining, in part by ensuring that their basket of investments is spread intelligently across the market’s valuation spectrum.”

But what does it mean to spread your investments “intelligently across the market’s valuation spectrum?”  I think it means many different things to many different people.  One investor’s goals and tolerance for risk may be far different from another investors.  Before a pitch for some mutual funds, Mr. Zimmerman describes that value stocks should hold up better in a down market than growth stocks.  No real surprise there- growth stocks command a risk premium that value stocks may not since they have already fallen in value.  Growth stocks may have greater volatility with potentially greater variance of performance over time- higher returns in good times and lower returns in tough times.  One way to look at it is using a statistical measure called beta.  In essence beta is used to measure risk based on volatility, with the market having a statistical beta of 1.0.  Stocks with beta higher than that are potentially riskier, but also may yield a higher return.  Stocks with a beta lower than the market are less volatile and less risky but also have a lower expected return.  So value stocks should have a lower beta than growth stocks right? Not necessarily… if a high-flier stock has fallen greatly and some may consider it a value stock, it actually may have a higher beta and be classified as more risky after it decreased in price! Why? Because beta measures volatility. Beta can be a useful measure, but it’s only one way to look at risk.  Beta doesn’t work very well when price movements are considered.  There is a key issue here, and Investopedia has a great discussion of it in an article titled “Beta: Know the Risk“ from 2004 by Ben McClure.   For me, the big take-away is how I approach investing for the long term while considering the fundamentals.  From the article and a reference to Ben Graham:

“Try to spot well-run companies with a “margin of safety”–that is, an ability to withstand unpleasant surprises. Some elements of safety come from the balance sheet, like having a low ratio of debt to total capital. Some come from consistency of growth, in earnings or dividends. An important one comes from not overpaying. Stocks trading at low multiples of their earnings are safer than stocks at high multiples.”

I don’t know where we go from here… but I try not to care too much.  Saying I don’t care would be a specious statement… of course I care how the market and my investments do!  But at the same time- I agree with preparing for the down side because it will come… it’s just a matter of time.  When I’m better prepared, I’m less inclined to fret over market movements.  How we prepare for those times is the question, and my answer is to focus on fundamentals, invest for the long term, and keep on learning along the way.