Sailing through the financial storm

“It is the set of the sails, not the direc­tion of the wind that deter­mines which way we will go.”

— Jim Rohn

Sail­ing is an inter­est­ing study of physics. A novice would sup­pose that the best way to sail would be to posi­tion your­self with the wind to your back and let the wind drive directly into the sail dri­ving you for­ward. Basi­cally, “Let’s set sail and see what happens.”

Many investors and advi­sors alike set sail in the 1980s with the wind to their backs with­out a cloud in the sky until year 2000. They entered the per­fect storm, and woke up bro­ken, dis­ori­ented and scared. A nau­ti­cal expert under­stands that there are many forces to be man­aged and can nav­i­gate through seem­ingly impos­si­ble cir­cum­stances. An expe­ri­enced sailor is not sim­ply dri­ven by the wind, but under­stands that the wind is a power to be har­nessed and can even be used by that cap­tain to sail directly into, and at the same speed as, that very same wind blow­ing into his face.

It is imper­a­tive when sail­ing through rough finan­cial waters, that the investor rec­og­nizes that his finan­cial boat is not meant to sim­ply be tossed around on the waves of the stock mar­ket. The stock mar­ket is indeed a tool like the wind that must be har­nessed by an investor with understanding.

Many of you may have heard the rum­blings of a storm com­ing in. Maybe you have been watch­ing the clouds of Europe roll in, or maybe you heard the crash of thun­der from last Friday’s dis­ap­point­ing employ­ment report. Maybe you have already made the appro­pri­ate changes, or maybe you are just scared to death. Here is my Sur­vival Guide for Nav­i­gat­ing the Cur­rent Finan­cial Storm. It is cer­tainly not exhaus­tive, but can serve as a com­pass as you con­sider bat­ten­ing down the hatches in choppy markets.

Under­stand your invest­ment strat­egy. There are basi­cally two types of invest­ment strate­gies —pas­sive and active. Pas­sive invest­ing is a form of buy and hold with few changes over a long period of time. No gains are locked in until an asset is sold, usu­ally because money is needed from the account. Active invest­ing seeks to buy low and sell high. Invest­ments may be sold sim­ply to cap­ture a gain or man­age a loss, and not nec­es­sar­ily because money is needed for withdrawal.

Pas­sive Investors: As I have men­tioned in arti­cles past, man­ag­ing risk is the first order of busi­ness. The first step is to be sure that your hold­ings are well diver­si­fied over many asset classes or sec­tors. Once this basic step is done, it is essen­tial to know the level of risk that your account is exposed. This can be eval­u­ated using a finan­cial sta­tis­tic known as beta. Beta sim­ply mea­sures the risk of your invest­ments as com­pared to a bench­mark such as the S&P 500. A beta of 1 would mean that your account has equal risk to, and will feel all the move­ment of, the S&P 500. A beta of .5 would mean that your port­fo­lio holds only half the risk of the S&P 500. Dur­ing choppy mar­kets like we are expe­ri­enc­ing now, a beta between .5 and .8 would help dampen the blow from a mar­ket down­turn. Your finan­cial plan­ner can pro­vide you the beta for your port­fo­lio or you can use a quick Google search for “port­fo­lio beta cal­cu­la­tor” to find instruc­tions or tools to accom­plish this. If you are risk adverse, you might con­sider mak­ing port­fo­lio changes to bring your beta into this range by adding alter­na­tive invest­ments such as cur­ren­cies or commodities.

Active Investors: Diver­si­fi­ca­tion will greatly impact your risk as well. This is a good time to con­sider tak­ing some prof­its from pos­i­tive trades and tight­en­ing your stops on all trades. Another option to con­sider is low­er­ing your invest­ment dol­lars per trade to allow your posi­tions more wig­gle room to work. Invest in hold­ings that do not move in lock step with the mar­ket, but are dri­ven by a com­pletely dif­fer­ent set of factors.

Real­ity Check: The stock mar­ket is now at the same lev­els we expe­ri­enced around year 2000. That means a pas­sive investor directly invested in the stock mar­ket would have risked money through a ter­ror­ist attack, a finan­cial cri­sis, a hous­ing cri­sis, a reces­sion and now a Euro­pean cri­sis for 0 per­cent return. Today’s investor must not rely solely on the stock mar­ket to pas­sively pro­vide a gain. One must expertly nav­i­gate to get pos­i­tive trac­tion in a choppy market.

Real Advice for Real Peo­ple: Like an expe­ri­enced cap­tain, you must rec­og­nize the finan­cial weather and nav­i­gate accord­ingly. The sim­ple buy and hold men­tal­ity with no risk man­age­ment is no longer accept­able. Now is not the time to let fear keep you from open­ing up your account state­ments. Make it a point to work with or learn from a pro­fes­sional and tend to these areas. Fol­low­ing these steps will help give you the thrill of the voy­age with­out the Gilligan’s Island experience.

RC Arse­neau is a Cer­ti­fied Finan­cial Plan­ner and lives with his fam­ily in Delaware. Please sub­mit any ques­tions or topic requests to AskRc@mail.com.

The infor­ma­tion and opin­ions in this col­umn are pro­vided only for edu­ca­tional and enter­tain­ment pur­poses. Any ref­er­ence to a finan­cial prod­uct or strat­egy is not to be con­sid­ered an endorse­ment or rec­om­men­da­tion. The infor­ma­tion is of a gen­eral nature only and does not take into account your indi­vid­ual objec­tives, finan­cial sit­u­a­tion or needs. It should not be used, relied upon, or treated as a sub­sti­tute for spe­cific pro­fes­sional finan­cial, legal or tax advice. Invest­ment Per­for­mance may vary due to tim­ing and expenses. Rc rec­om­mends that you obtain your own inde­pen­dent pro­fes­sional advice before mak­ing any deci­sion in rela­tion to your par­tic­u­lar require­ments or circumstances.

Posted by RC Arseneau on Jun 5 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.