Financial Fortitude

Investors may be nervous in these turbulent economic times, but with tried and true strategies, area experts say their assets can continue to grow

The government is bailing out big, troubled companies … or not. The Dow is plummeting … then recovering. Gold prices are at record highs … then backing off a bit. Nationally, the real estate market is in turmoil … although locally it’s more stable. 

It can make you want to hide your money under a mattress. Or at least pull out of the market and invest it all in something safe, like CDs. But what if the market picks up and you miss the associated earning potential? Or, conversely, you might have a stock whose price is nose-diving, but you don’t want to sell low so you hang on.

Either way, you’re allowing emotion to rule your financial decisions, and that’s one of the biggest mistakes investors can make, indicates Michael J. McKersie, CFP, managing financial advisor at Clifton Gunderson Wealth Manage- ment. “The biggest example was during the [dot.com] bust—a lot of people had started doing individual investing, and it was very hard for them to admit they’d made poor choices. As their stocks went from $100 to $5 a share, they kept thinking they’d come back. People who’d made millions lost it.”

Stick to the Plan

To combat emotion, investors should work with a professional advisor, have a plan, and stick to it in good and bad times. The first step is to determine your specific goals. Why are you investing money? Is it for retirement or for your children’s education? And what’s your time frame to reach those goals? Look at your tax situation, too; investment instruments’ tax impacts can vary.

Next, determine your willingness to handle risk. “What is too risky for you? What are you willing to lose in the effort to make money? Everybody has a different definition,” McKersie says. “There are several basic risk-type questionnaires online to help you evaluate your tolerance, and advisors have more sophisticated ones.”

Then you can build a portfolio that fits your situation and outlook. The most challenging part is asset allocation. How much should you have in stocks? Bonds? Large, midsize or small companies? Domestic or international companies? “Identify what percentage of your money should be in each asset class, based on your risk tolerance,” advises McKersie.

He advocates mutual funds, and says you can then find funds that include the asset classes you want. “Too often people just buy one mutual fund. If it does well, you win. If it does poorly, you lose. We prefer to spread that risk over a variety of asset classes.”

When people get worried, they sometimes try to time the market, and be in one investment today and out tomorrow. “But it’s hard to know what the market will do short term,” McKersie says. “If you have a varied portfolio, you can shrug your shoulders if one fund does poorly. Something else will do well.”

He recommends developing a written investment policy statement (IPS) that lays out your strategy. “It really becomes important in times like this,” he says. “If you have a policy to get through good times and bad, it’ll help keep you from panicking and selling off at the wrong time. If the market falls, you can go back to your IPS and look at, ‘Here’s why we invested the way we did.’ You may need to fine-tune some things, but you won’t go to cash and maybe miss a market upturn.”

Have certain asset classes done better than others over the last year? “Gold has had a nice run, as have some commodities [like grains],” McKersie opines. “They’ve pulled back a little, but have been some of the better performers since last Nov- ember when the market started to drop. We don’t know if there’ll be significant short-term growth right now, but we still feel they’re assets worth holding.”

He has a caveat. “If you only have $1,000, it’s hard to build a portfolio of 12 or so mutual funds and add satellite positions like gold or emerging markets. With $100,000 or $1 million, the question becomes, what percentage do you put in gold or silver? We probably wouldn’t recommend more than five percent for most people walking in the door.”

Gold doesn’t ebb and flow with the stock and bond markets. “It moves independently of those, so it becomes a good diversifier for higher-net-worth investors,” McKersie says. “We still like commodities as a satellite position too, but we’d probably recommend the general investor hold under seven percent of assets in a diversified commodities mutual fund.”

The average investor should probably avoid stock options, futures, penny stocks (those trading under $5 a share) or direct ownership of individual gold stocks or real estate, just from a risk standpoint, he advises. “It might be OK for very high-net-worth, especially savvy investors. There’s more risk, but the potential reward can be great.”

Diversify

Hedge funds, too, usually make sense only for very large portfolios. Most are available in a limited partnership format, so, by law, access is limited to wealthy investors, notes Mark Fedenia, portfolio manager at Nakoma Capital Management. Their managers “go long” with some stocks, or buy them with the intention of holding them as their value appreciates. They “take a short position” with others, or borrow shares and sell them short (right away), hoping the price goes down so they can repurchase shares at a lower price, repay the lender, and make money from the price differential. If the managers have forecasted correctly, it works.

“Long stocks move with the market and short stocks move against it,” explains Fedenia. His firm manages a limited-partnership hedge fund in which the minimum investment is $500,000. It also offers an option he believes is unique to the Madison area and is pretty uncommon overall—a mutual fund invested using a hedge-fund strategy—the Nakoma Absolute Return Fund (NARFX). The minimum investment is $1,000.

“The mutual fund only has traditional asset-based management fees, whereas our limited partnership has a lower asset-based fee combined with a performance-based fee,” he says. “It can fit into the smaller investor’s lifestyle portfolio. It’s designed to have a long-term eight- or nine-percent return with bond-fund-like risk, and to move on its own, not with the market.

“The key to diversification is combining assets that don’t move together when events unfold. To a degree, this co-movement, or lack thereof, is even more important than the level of risk,” he continues. “Some hedged mutual funds are higher risk and not great diversifiers, but ours is designed to smooth results and be on the low-risk end of the spectrum.”

He recommends investors work with a registered investment advisor. “Our fund is very liquid—like any mutual fund—but its behavior is different from traditional bond and stock funds. A registered advisor can help you decide how much to put in your portfolio, along with stock and bond funds.”

Educate Yourself

Even if you have a registered financial advisor, it’s helpful to have a basic understanding of investing. An investment club can be a great way to build that knowledge. Members do research, meet regularly, pool their funds and decide how to invest them.

Erika Braunginn is a founding member of the Madison Bull Market Investors, the city’s first all-African American investment club. “It’s a place where we can support each other and learn together. We can ask stupid questions and help each other out. It’s a learning, an investment, and a networking opportunity,” she says. “And we’ve realized we’re breaking the stereotype that black people can’t manage their money, that they don’t know about investments.”

If you start a club, Braunginn recommends going slowly, talking to other clubs, writing your bylaws carefully, and having a good advisor. Her group began in January and made its first investments in August. Its 19 members will continue to educate themselves and stick to their plan, in good times and bad.

Judy Dahl is a contributing writer for Madison Magazine.

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