Thoughts On: Managing your Portfolio in Uncertain Times
I’ve been paying attention to the stock market for over 30 years, and I can’t remember any times that weren’t uncertain. I checked with Ron, who has been paying attention since 1968, and he can’t remember any times of certainty either.
When I think about managing your investment portfolio in uncertain times, I start with these questions:
- What is uncertain today?
- What has been uncertain in the past?
- Were these unprecedented at the time?
- How did you manage your portfolio then?
- What did you learn from that?
For example, the 1970’s were unprecedented in having high inflation combined with high unemployment, and they were chock full of uncertainty regarding oil prices, inflation, interest rates, etc. etc. etc. Today we have uncertainty on all of those things, plus currencies, Europe, China, etc. etc. etc. One thing I’m certain of is that we will always have uncertainty to deal with. All times are uncertain times, so we can reasonably change the topic to “Managing Your Portfolio.”
People worry about a lot of things they CANNOT control and spend time trying to predict things they CANNOT know. Time and energy is better spent on things we can know and can reasonably rely on.
When managing a portfolio, we can know what it is we are trying to accomplish, and we can define that objective in clear and quantifiable terms. Financial planning can help us create a personal “Statement of Investment Policy” that defines our portfolio objectives. A financial plan describes where you are, where you want to be, when you want to be there, and what you have to do with your money to get you there. It puts dates and dollar signs on the significant milestones of your life: getting married, buying a house, paying for college, retiring, traveling around the world, etc.
You then use that information to create a statement of investment policy, which provides you with your number. When people want to talk about investment performance, I ask “What’s your number?” and they don’t know what I mean. I mean, what performance do you need to achieve all the financial objectives you have set for yourself?
Based on my assets, my spending, and my savings, I am reasonably certain that growing my assets 5% after taxes and inflation averaged over periods greater than 5 years will get me where I want to go. My number is 5% real, after-tax returns on a rolling five-year average. What’s your number?
Once I’m certain about my number, I start looking for the combination of securities, asset classes, or money managers that can help me hit my number. I’m indifferent as to whether my assets grow through interest, dividends, or capital appreciation since, regardless of my age, I can always convert assets to spending money; the key is to keep the assets growing. I’m certain that stocks should make me more than bonds, and the Ibbotson[1] charts tell me stocks have most frequently cleared my required 5% real, after-tax return, so I think that stocks are normally more likely to earn what I need. I’m also certain that stocks are more volatile than bonds, so I keep a year’s worth of living expenses in very liquid, very stable, savings or money market accounts. This is so I can buy low, sell high, and not be forced into selling to meet a financial emergency.
I’m certain that between church, family, work, the gym, the motorcycle, and the rifle range I don’t have more than a couple hours a week to spend managing my portfolio, nor have I been blessed with the temperament to pour through reams of financial, economic, and corporate data; so I have hired a professional that is honest and competent to manage my portfolio for me. He spends 60+ hours a week on managing my portfolio and is accountable for hitting my number, which he has assured me is reasonable and has managed to do for me since I hired him.
What else am I certain of?
Prosperity is a function of what you spend, not what you make. Having a portfolio requires you to earn a buck and save a quarter. John Templeton claimed the key to his wealth was saving fifty cents from every dollar he earned for the first 20 years out of college. I’m certain that if we followed his example, we would also be wealthy.
Compound interest is hugely powerful but takes time to work. Start making more and spending less early so you have LOTS of time for compounding to work for you.
People are hard-wired to be bad investors. The work on Behavioral Finance and Behavioral Investing describes the various ways this is true and the reasons for it, and the DALBAR QAIB study puts numbers to just how much it costs investors.
It is critical to be clear about your own financial goals and required returns. By knowing “your number” and focusing on what you can control—your savings rate, your spending discipline, and your investment temperament—you can navigate through perpetually uncertain markets with confidence. External factors like inflation, interest rates, and geopolitical tensions will always create uncertainty. A carefully structured approach based on proven principles will put that uncertainty to work FOR you. The trick to investing is not trying to master uncertainty, but to build a portfolio that can thrive on it.
The opinions expressed are those of Anthony Muhlenkamp and are not intended to forecast future events, guarantee future results, or offer investment advice.
Investing involves risk. Principal loss is possible.
[1] Ibbotson® Stocks, Bonds, Bills, and Inflation After Taxes and Inflation chart
