Rx for Portfolio Stress

These days, it is tricky to write an article about financial markets so far in advance of the publication date. The world can change so quickly that anything I say could become dated very quickly. Frankly, I hope what you are about to read is totally out-of-date, because that would mean that financial markets have recovered nicely and you no longer have any anxiety about your financial future! If that's the case, file this away for the next financial crisis that will eventually come around.

On the other hand, the level of anxiety is so great for so many people right now, I feel compelled to write about this important topic. There's more angst, fear, and anxiety about the market today than I remember from any time in my professional career.

"These are the times that try men's souls," wrote Thomas Paine, in a series of pamphlets about the Revolutionary War entitled "The American Crisis." He went on to say, "The harder the conflict, the more glorious the triumph. What we obtain too cheap, we esteem too lightly: it is dearness only that gives everything its value."

We now find ourselves in a new, financial and emotional war, as a result of successive years of shockingly negative market returns and a crisis of confidence -- caused first by 9/11, then by a series of revelations, beginning with Enron, that has caused the ethical fiber of our corporate institutions to be called into question.

We simply don't know what (or who) to believe anymore. We now distrust the very institutions that have been the cornerstone of our economy. A corporate quarterly earnings report comes out and we say, "Yeah, right. We've heard that before!" Cynicism is at an all-time high.

Think long-term

Intellectually, we all know that markets move in cycles -- not in long-term ups or downs. While it may feel at this moment as if your portfolio is going to march inexorably down, that's highly unlikely. If I had a wish, it would be that you would take a deep breath, ignore the media frenzy, and stop looking at your portfolio for about six months. As confidence returns, so will the markets. We're simply in the middle of a panic-selling phase -- people are selling willy-nilly in order to get some emotional relief. That has consistently proven to be a formula for disaster.

I recently received a white paper from EnvestnetPMC called "The Case for Optimism," which was a compendium of recent market commentary that highlights the strength behind the American economy. Here's an excerpt from this paper, used with permission: 

While sentiment is low, there is important historical context that investors should understand. Giving in to a negative market has historically defeated investors with long-term goals. Studies have repeatedly shown that frequent switching of investments can hurt investment returns.

The results of a study performed by Dalbar Inc. and Lipper Inc., show that from 1984-2000, the average stock fund delivered an average annual return of 14.0 percent, while the average stock fund investor earned only 5.3 percent annually per year. This equates to a cumulative return of 841 percent for the average stock fund versus a cumulative return of only 141 percent for the average stock fund investor. The reason? Investors sell into weak markets, and buy into rising markets far too late. Frequently, investors' attempts to protect themselves compromise the ability of a diversified portfolio to succeed over time. A lesson learned time and again in the stock market is that short-term thinkers rarely prosper while long-term buy-and-hold investors benefit from their resolve.

What should you do?

With that said, here's my prescription for survival in today's market.

Put the market volatility into perspective. The current situation is simply one more of life's uncertainties. Yet it hardly compares with life's real crises -- death of a loved one, loss of a job, the end of a marriage, a terrible accident or medical diagnosis. Without getting too philosophical, I ask you to reflect on two questions:

•  How have you handled other crises in your life?
• In what do you place your confidenceso that you're able to take one day at a time when crises strike?

Next, add "smart diversification" to your portfolio. While I recommend that you have your portfolio evaluated by either a financial professional or a Web service such as www.financialengines.com, there are a few benchmark relationships that you can apply to your portfolio in the interim.

The hard decision is "What percentage should I invest in equities versus fixed income?" If you're a conservative investor, consider 25 percent in equities. For moderate investors, consider 55 percent. Aggressive investors, go for 80 percent.

Finally, rebalance your portfolio with discipline. This causes you to "sell high and buy low." After 9/11 last year, we conducted extensive studies to determine the optimal approach to rebalancing. Many firms use their calendar to rebalance, doing so on a quarterly or annual basis. Unfortunately, markets don't know or care what month it is. We found that a "conditional" rebalancing approach creates superior results and therefore use what is called a "25 percent decision rule."

Here's how this rebalancing approach works. If your target allocation for an asset class is 10 percent of the portfolio and it goes up past 12.5 percent or below 7.5 percent, we would rebalance the entire portfolio and bring all the asset classes back to their original targets. This technique helps you make objective, not emotional portfolio decisions.

I know this is a difficult time. Yet, if Mr. Paine was correct (and if you'll follow my prescription), we are all hopefully headed toward one "glorious triumph" -- and in the process, may you find your "dearness" that gives everything its value.

Rick Adkins, CFP, ChFC, MBA, is CEO of the Arkansas Financial Group Inc., in Little Rock, Ark. He has been listed in Worth magazine's "Best Financial Advisers" since 1997 and Mutual Funds magazine's 2001 and 2002 lists of "100 Great Financial Planners." He can be reached at RickA@Arfinancial.com or via editor@physicianspractice.com.

This article originally appeared  in the November/December 2002 issue of Physicians Practice.