Others to blame for woes? Try looking closer to home

January 5, 2009
Investors were mad as hell last year as they watched their portfolios melt. And who can blame them?

But even after holding Wall Street, banks and the government accountable, these investors should look in the mirror. They took on too much debt and should take responsibility for their actions.

Individuals -- along with the banks, big businesses and big government -- must tighten belts. We've got to kick our habit of keeping up with the Joneses and learn to live, and enjoy living, with less. In fact, the crisis can be viewed as a sort of fiscal cleansing, even if it is a cold-shower way of learning responsibility.

Consumers have lived beyond their means for a long time. Look no further than families who grabbed interest-only or adjustable-rate mortgages to buy homes beyond their budgets. Fingerpointers tell everyone that the "creative" packaging of these dubious mortgages into securities and the lax regulation of the process caused today's problems. While true, don't forget that all those dumb loans were taken out by consenting adults.

A mortgage broker or banker can flatter you into thinking you can afford the dream mini-mansion even though you know the modest fixer-upper is within your means. But bankers and brokers peddle mortgages and are not paid to see that you do what's prudent.

Now is a great opportunity to rethink how to live within your means and learn how to handle money. We should always prepare for the worst and pray that it doesn't come.

Recently, I have been asked by several seasoned advisers whether it is time to rethink key tenets of what, at least until now, have been deemed generally accepted investment principles. They're reconsidering the modern portfolio theory of diversification and dollar-cost averaging because the theory has done little to protect investors from calamity.

This is a potential trap for at least two compelling reasons.

First, advisers are obligated under fiduciary conduct laws to diversify portfolios and apply generally accepted investment principles -- except in those rare circumstances when it is clearly prudent not to do so. Losses can be avoided when the market is down, but few advisers have a system in place to mitigate that type of downside risk.

Second, historians know markets go in cycles. At the end of 1999 we entered a secular bear market. Secular bear markets last a long time, maybe 10 to 20 years, and are characterized by below-average stock market returns.

The market tends to average annual returns of 10 percent to 11 percent. However, over the past decade the market has been relatively flat. An investor who put money into the market 10 years ago using a buy-and-hold strategy has about the same amount of money, prior to taxes and inflation, as what they put in.

Common cyclical bear markets are measured in months. So, the common strategy of staying the course through a cyclical bear market may not work because the secular bear market lasts a long time.

In spite of the current uncertainty, I believe the market will be much higher a decade from now. If history is an indicator of the future, the market's return to higher gains is likely close. Start preparing your portfolio to recapture your recent losses.

This isn't an easy time to rethink strategy. From a financial perspective, even advisers can have their confidence shaken. But the value of a skilled and ethical adviser is to replace chaos with success.

These advisers earn their fee in how they deal with adversity for their clients. Being able to severely limit clients' downside exposure last year was, of course, not easy, but what was expected.


Coan is managing partner with Indianapolis-based Wealth Planning & Management LLC, a fee-only registered investment adviser, and author of "Asset Protection and Wealth Preservation." Views expressed are the writer's.
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