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Avoid Sandcastles

Stock Market News

September 2001

Avoid Sandcastles

Where is the market headed? Let’s face it; that is a question lots of people are nervously asking. Regrettably, an honest person, regardless of education, training, experience, research, and skill, can only reply that the answer is unknown to mere mortals.

When an architect and a builder get together to create a custom built home, they can assure their client that the finished product will look exactly as he or she wants. Why? It’s simple, really. The architect controls the precise placement of every wall, every fixture, and every minor element. All of the design is under the complete control of this skilled professional. Likewise, construction materials such as wood, steel, and concrete have known, consistent physical properties which means the builder can take the blueprints and the materials and create exactly what the architect planned.

Imagine for a moment that construction materials have unknown properties. Worse still, imagine those properties can, and do, change from month to month, project to project and you find out that you’ve built on a bed of sand. Can any assurances be given to you in this strange new world? Of course not. Despite flawless plans that meet the exact needs of the buyer, the builder can no longer guarantee the outcome. The outcome is now beyond his control.

And so it is with the investment process. Investment professionals can carefully craft precise plans for a lifetime of successful investing that meet every stated need of the investor. Parameters for rate of return and risk can be established. Precise calculations can be made to determine an exact outcome for our money. But that is where the precision ends.

When it comes to implementing the designed investment portfolio, we encounter circumstances beyond our control. Investment tools, like construction materials, can be selected based on how they serve the plan. But in a world where the properties of our tools change frequently, we cannot be assured of the result. In a world of changing taxes and changing inflation, we cannot be assured of the result. In a world where emotion, not logic, rules investors’ minds, we cannot be assured of the result. In a world where policy makers control interest rates, foreign aid, and the money supply, we cannot be assured of the result.

What is the implication? Even in a strange world where construction materials have uncertain physical characteristics, is it not advisable to start with blueprints? Although a particular board might not behave predictably every time, would the buyer not stand a better chance of getting his dream house if the builder at least knew where the board is supposed to be placed? Most would agree, yes. With investments, we don’t know how technology stocks will perform in any given period, but knowing if they fit into our investment strategy, in theory, serves us well. Also, having a design illustrates for us what we want the portfolio to look like, ideally. Even if we cannot get it exactly right, at least the plan shows us what we are aiming for, and thus, having a plan is beneficial.

Even in a world where we cannot control the construction materials, would most folks still prefer a house to no house? Would a leaky roof not be better than no roof? The implication for investing is similar. Yes, investing is unpredictable in the short run, even downright scary as it is in the current environment. But, all the imperfection considered, we must invest! The rewards of investing outweigh the downside.

The S&P 500 Index stands at roughly 1,130. No one can tell you, with certainty, the direction of the next 50 points in that index. It could be up or down. But, we do know the direction of the next 1,000 points. Most assuredly up! If, for a moment, investors can get past their preoccupation with control, they will see the wisdom in that point. What are the odds that the index will go to zero versus the odds that it will double? All investors should bet on the double.

These are time for professional advice. We can help and let us begin with a few pieces of sound advice that can serve you well in these uncertain times.

  • Manage your risks. Never let any one investment represent more that 5-10% of your portfolio. Also realize that, for speculative investments, a long-term hold position can be a long-term loss position in a long-term bear market – which is where we are now.

  • Diversify your holdings among different types of investments.

  • Avoid high return schemes. It’s usually hype so you can geed someone else’s get rich quick plan.

  • Look for investments that are undervalued, look for where the puck is going to be, or as Bernard Baruch said “Buy straw hats in January…”

  • Generally, don’t follow the crowd. Remember that if a stock has gotten popular that its popularity has been incorporated into the price of the stock and it is not a good value.

  • Look at history. The more understanding on the current conditions can only be of helpful to you. Also consult several, tried and true, trusted sources on the current financial conditions. This excludes the Wall Street hawkers that prey upon the sentiments and fears of the unsophisticated investor. Watch the market. Ask for advice and keep your cool.

Be patient. Your builder is working with some unpredictable materials in a hostile environment. Make sure that you see progress. Even though the ground is shifting beneath your feet, you can put in pilings to keep things from moving around. In other words, monitor that your investment “house” looks more and more like the blueprints as you move forward, but don’t sweat it if a few elements of the plan don’t turn out exactly as planned. The better informed you are, the better partner you can be with your builder and architect. Know your materials, know the risks, and be sensible. That is simply part of building, and managing a portfolio – and life.

These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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