Investment Planning: Caution and Opportunity

Overly cautious investing could be costing you. Make sure your portfolio balances cautious investing with taking advantage of opportunities that may offer larger returns.

bull and bear on a seesaw

On October 9, 2007, the Dow Jones industrial average topped out at 14,164 points. Almost 18 months later, it had tumbled nearly 54 percent to 6,443. The fall was gradual at first, but the implosion of investment bank Lehman Brothers in September 2008 turned what was simply a slump into the biggest economic downturn in the U.S. since the Great Depression.

Those fortunate enough to exit the market before the plummet probably counted themselves lucky. So, too, did those who escaped before the nadir was reached. But if those people continued to hold onto their cash from the time they exited until now, as many have, they likely feel a little differently.

"If you look back to October 2007 through to the fourth quarter of 2013, cash earned about 3.6 percent on a cumulative basis," says Chris Haverland, Asset Allocation Strategist with Wells Fargo Private Bank. "The S&P 500 dropped more than 50 percent during that period, but since it hit the bottom, it's climbed nearly 180 percent."

The result of those ups and downs? On a cumulative basis over the same period, the S&P is up 39 percent, as compared with the 3.6 percent cash return. "People may have missed the drawdown, but they also missed a huge opportunity on the upside," says Haverland.

Timing the market
Some could argue that the figures above are an unfair yardstick. After all, few investors would have had the prescience — or presence of mind — to enter the equity market in March 2009 and capture gains of 180 percent. But another view of the same 2007 to 2013 period is more revealing.

"The Wells Fargo balanced portfolio drawdown was closer to 30 percent during that period, and the rebound was nearly 100 percent," says Haverland. "For the entire period, the cumulative gain was about 32 percent."

One takeaway is that it's very difficult to time markets, so it's generally wise to remain invested throughout the market cycle. Another lesson is that overly cautious investing may prove more hazardous to a portfolio than what might appear to be risky investing. 

"People get too emotionally involved in investing. Fear and greed can lead to poor decision-making," says Haverland. "When people see the stock market plunging, no one wants to be in equities. Similarly, when stocks are rising, investors wonder why they own anything but equities."

As investors look at the strong 2013 equity market returns and their fear of market corrections recedes, this latter concern is being voiced more frequently. Haverland believes the best path continues to be to remain fully invested in a well-diversified portfolio.

Overcautious investing and lifestyle
In a survey published in Forbes magazine in 2012, high-net-worth individuals said that what they most sought from their advisors was advice on how to maintain their current lifestyle. But today, maintaining your lifestyle can be difficult, especially if you're invested primarily in fixed income.
 
"If you have your money in treasury bills right now, which are earning a few basis points, from a real rate perspective you're actually getting a negative return; you're not even outpacing inflation," says Haverland. "Just to cover inflation, you have to earn at least 3 percent annually on your money over the long term."

Revising your investment style
Altering your investment behavior doesn't happen overnight. But Haverland says a good place to start is by improving your personal investment education. Your relationship team is a good source for recommended reading and seminars, and they can point you to white papers and other materials from The Private Bank that will expand your investing knowledge.

Among other things, these resources provide empirical evidence about the upsides and downsides of different investment strategies.

Taken together, all of these can give an investor the confidence and knowledge to make more informed investment decisions. It can also help make him or her a less cautious but more prudent investor.

Options for the cautious and the opportunistic
Too many times investors focus on specific investments that they feel they should own. Haverland says that they need to focus less on what they own and rather why they own it. Investors may want to meet with their investment team to discuss what the money is for.

At the heart of each investment strategy is asset allocation. Asset allocation is the process of combining different asset classes — such as equities, fixed income, real assets, and complementary strategies. It has the intent of optimizing the relationship between risk and return while meeting the investors' need for cash flow, liquidity and growth among other considerations.  

"Change the conversation from one about today's hot investments to one about what assets are expected to do under different scenarios," recommends Haverland. "Begin looking at the various elements of your portfolio as a way to prepare for most eventualities."

The question of "What is the money for?" is a big-picture question that looks at what investors want from an investment portfolio and when they will want or need it. Changing the conversation to why you own specific assets has the potential to provide a much more comprehensive approach
to addressing the needs of your balance sheet.

Removing emotion, whim, and instinct from investment decision-making is essential, if only because these things have almost no statistical chance of aiding an investor. 

"We preach being fully invested in a globally diversified portfolio. We are not market timers, and advocate investing with a goals-based approach," says Haverland, who highlights a final set of statistics that illustrates the danger of solely being reactive.

Excluding dividends, "anyone fully invested in the S&P over the past 25 years would have enjoyed an annualized return of 7.9 percent," says Haverland. "But if you had missed the market's 10 best days, your annualized return would have been 4.9 percent; and if you missed the best 30 days, your annualized return would have been around 1 percent."

Ian Driscoll is a freelance writer whose work has appeared in the Financial Times and Weekend Financial Times.

Image by Clint Hansen

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The information and opinions in this report were prepared by the investment management division within Wells Fargo Private Bank. Information and opinions have been obtained or derived from sources we consider reliable, but we cannot guarantee their accuracy or completeness. Opinions represent Wells Fargo Private Bank's opinion as of the date of this report and are for general information purposes only. Wells Fargo Private Bank does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses.

This information is provided for educational and illustrative purposes only.

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