Investor Inaction Costly – GET TOUGH

Posted on September 3, 1990 by VM

CINCINNATI BUSINESS COURIER
September 3-9,1990

Investments
By Charles D. Vaughan

Investor inaction costly amid crisis in Mideast

GET TOUGH.
There’s an old saw that says, “When the going gets tough, the tough get going.” This is a trite but true expression. At no time in the past decade has it been more apropos than now.

The Mideast crisis has challenged America and other freedom loving nations to action. Doing nothing is not a viable option. The reverberations throughout the world financial markets have issued a similar challenge to investors. Inaction could be costly.

What’s changed? Since Iraq moved against Kuwait there have been at least three major long term changes in the financial markets. If, by some miracle, a peaceful resolution were achieved tomorrow, these would remain.

The sky has fallen. There are now thousands of Chicken Littles with press cards running around spreading panic. Any longtime market observer can tell you that the news follows (and justifies) the action. With stock and bond markets both dropping, there is now a plethora of negative “news” to explain why. Repetition builds belief. Market psychology shifts from “make me more money” to “get me even and get me out.”

The Emperor has been seen naked. For the past several years, we have been pounding our national chest about having defeated the business cycle. Recessions are a thing of the past, right? Now we are faced with the gutwrenching truth that it was mostly illusory. The price of staying the course has been a massive buildup of debt at all levels: federal, state, local, corporate and personal.

Now, in the midst of righting a massive budget deficit and an omnivorous savings and loan bailout, we are forced into an expensive conflict. Debt is an issue that can’t be ignored any longer. Risk is real. There is an unmistakable flight to quality.

Pandora’s box has been opened. The United States, and much of the Western world, has kept the lid on inflation despite positive economic growth and rising debt. Many other parts of the world have experienced hyperinflation accompanied by a weak economy. Deft mental partitioning has allowed us to maintain the attitude that our results came from superior monetary management.

The spontaneous combustion that blew oil prices skyhigh overnight woke us up. Energy prices are unlikely to recede to precrisis levels. These higher costs will soon be a good excuse for others to follow suit. It should now be obvious to any who cares to look that economics cannot be controlled by a small group of people meeting periodically to nudge interest rates to and fro. Inflation is contagious and we are not immune.

We have been spoiled by relatively well behaved financial markets for the past several years. Now they have begun to act up. Most investors have seen their portfolio values drop sharply. Inflation has reappeared and motivation has shifted from greed to fear. The going has gotten tough. What can you do about it?

The first step is to review your defense. There are two ways to reduce risk  balance and diversification. Balance also is called asset allocation. This means spreading your investment funds across several different classes of assets that have different economic characteristics. By maintaining set ratios of investments in each class, it is possible to hedge against inflation, recession and economic upheaval at the same time.

Because of market action in recent years, most investors have little protection against inflation. Serious consideration should be given to establishing an allocation for real estate, energy and tangible investments.

Diversification  means not putting all your eggs in one basket. This relates to spreading funds among different investments within the asset classes. No matter how careful we are in selecting, some investments will always do better than others. This protects us from having everything in the underperformers.

The second step in your review is your offense. Once you have a sound strategy defining your asset allocations and establishing your diversification method, you can look for the best profit potential. Frequently after a drastic drop in market prices, true values emerge. This is a great time to upgrade your portfolio.

The first consideration should be risk reduction. With a new emphasis on quality, any investment that appears vulnerable to a slow economy or rising interest rates is suspect. This includes many leveraged buyouts. On the other hand, closed end mutual funds may fall to deep discounts in a bad market actually offering less risk and more return.

The important point is that tough times will crush the overextended and poorly managed enterprises. The well financed and managed will survive and prosper.

Damon Runyan said that the race is not always to the swift nor the battle to the strong, but that’s the way to bet.

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Old Skipper

Posted on June 12, 1989 by VM

CINCINNATI BUSINESS COURIER
June 12-18, 1989

Investments
By Charles D. Vaughan

The smartest dogs leave fast track to greyhounds

SKIPPER WAS A GOOD OLD DOG, but he had a big problem. He liked to chase cars. Try as we might, we couldn’t convince him it was a bad idea. Not only was it unproductive, it was downright dangerous.

A lot of investors seem to have picked up the same bad habit. I don’t mean chasing cars, but chasing markets. In fact, there may be a little bit of Skipper in all of us when it comes to investing. Nobody wants to miss a big chance to make lots of money. Unfortunately, most of us don’t get the urge to run until we see the market going by.

Studies have shown some interesting facts about fasttrack investing. The most important ideas have to do with risk aversion. Oddly enough, the most riskaverse investors are the worst performers. The reason for that is found in basic personality traits.

Greyhounds are built for speed. They are lean and mean and can maneuver quickly. In the volatile markets, the greyhounds have the edge. The most likely winners are those who are willing to assume a risk position at the first sign of potential. They do so because they are also willing to change direction quickly if their position seems doubtful. They are very low on the risk aversion scale and don’t mind being wrong a few times to get in the right position. They are willing to cut losses quickly and will ride a winner until it starts to falter.

Bassets are built for comfort. They are slower moving and need to be more deliberate in their actions. They are very high on the risk aversion scale and want to be certain they are right before making a commitment. For the most part, they avoid the fast track. They know their limitations and need a lot of convincing to commit to the chase. That is the trouble. Markets top out (or bottom out) when the most risk averse (hardest to convince) player finally decides he has enough information to make a decision.

That’s why some people claim that they always buy high and sell low. They do! They are always mystified because “everything said prices were going higher.” Right; so who was left to buy at higher prices?

Most of us are not greyhounds (including most players on the fast track). Neither are we bassets. We are more like Skipper, just a blend. But, we are subject to the tendency to get just the right amount of information to convince us to take the plunge at the wrong time. So, how can we avoid the temptation to make the same old mistakes again?

I have found two methods that work pretty well for all but the most hopeless cases. The first is simple dollar cost averaging and the second is asset allocation. Both approaches require that you have the discipline of planned investment policy.

Dollar cost averaging is a technique for investing a set amount of dollars into a given investment on a regular basis. This is most useful for those who do not have a large portfolio and want to build for the future. Many people invest in one stock (usually in a company plan). Others invest in a diversified portfolio of stocks through a mutual fund. The advantage is that using the same dollar investment buys fewer shares when prices are high and more when prices are low. This makes the average cost always lower than the average purchase price. It is a good longterm strategy when combined with other investments.

The second approach is better suited to those with larger investment portfolios. It used to be called portfolio mix, but is now called asset allocation. This method calls for establishing percentages of the total dollar holdings to be placed in various asset categories. For example, one might put 50 percent of available funds into fixedincome investments and the other 50 percent into equities such as stocks. Some managers would then strive to maintain that balance by shifting dollars from stocks as they rose into bonds or vice versa.

Most professional managers now use more asset classes to provide greater balance and diversification to spread risks. The purpose of this approach is to achieve a good return at the least risk. When properly managed, it calls for minimal shifting of funds which keeps transaction costs down. Some managers change the percentages on a regular basis such as quarterly. This is mostly selfdefeating because it institutionalizes market chasing.

Old Skipper never caught a car. I don’t know what his plan was if he ever had. But, one caught him much to our sorrow. I wish he’d left the fast track to the greyhounds. Maybe we can learn from his mistakes.

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