10 penalties that apply to investors as well as to football players

Brooke’s note: As Sunday’s big game approaches, more people would rather think about football than investing. Thanks to Rob Isbitts, you don’t have to make that choice. He has written a column that goes long on football analogies and hits the mark for giving perspectives on coping with the current market conditions. His point #9 really caught my attention because you don’t read much about it. When is firing your financial advisor a good cut for the team and when does it constitute unnecessary roughness?

I have observed that investors and their financial advisors occasionally commit a variety of investment management “penalties.” There is a certain perspective that all truly long-term investors must return to in times of financial uncertainty.

There is more to wealth management than guessing whether you should be “in the market” or “out of the market.” And, simply saying “stay the course” when there may be serious issues in one’s portfolio is a recipe for more of the same.

So, here is our list of official National Football League penalties — as applied to investors. Don’t get penalized, think your way through today’s environment, or find a money management specialist who can.

Human nature

1. False starts – 5 yard penalty. It is human nature to be optimistic about the ability of the economy and the markets to eventually bounce back. We do believe things will get better, and then much better in time. However, making an investment in something simply because it is way down in price is, like hope itself, not a strategy. Economies, markets and human emotions recover in a “U-shaped” pattern, not a “V-shaped pattern.” That is, they go through several little bi-polar episodes before they return to sanity. Don’t fight that, expecting to “get even” quickly. Focus on keeping losses short-term in nature and shallow in magnitude, and be opportunistic instead of aggressive. There are many investment approaches to accomplish this, and eveyone needs to identify with one they are comfortable with. Still, those are words we live by at Emerald.

2. (Buy-and-) Holding – 10 yard penalty. Just because your time horizon is long, doesn’t mean you can’t sell something. As you can tell by the first penalty covered here, there is a balancing act to investing, especially today – practice diligent risk management, but don’t just curl up in a shell and take no risk at all. If you do too much of the latter, you may get called for “Intentional grounding” (5 yards plus loss of down) of what otherwise could be a productive portfolio.

Sitting on the sidelines

3. Delay of game – 5 yard penalty. Going to cash or freezing up as an investor is fine if your current and forever goal is capital preservation to the exclusion of everything else, and inflation is not a concern to you. I congratulate those that timed their way into an all-cash portfolio last year. However, the risk of “sitting on the sidelines” for long periods of time is that you will forever be trying to pick your spots to “get back into the market.” That is a skill that is tough to master over and over, and for those with long-term investment objectives, it can be as much of a detriment as being too aggressive. We raise our cash position as a “weapon” and portfolio hedge quite often; it’s the all or nothing scenarios we are warning against here.

4. Pass Interference – 15 yard penalty. We are calling this one on the mainstream media and the big, impersonal investment firms. In their supposed efforts to “help” investors, they continue to present a message that has become a cliché, but to the detriment of many, oversimplifies some general investment concepts. Examples of this oversimplified advice include the following. We have summarized the other side of this conventional wisdom here as well:

a. Buy low cost mutual funds – in tough markets, net return, not cost is what matters
b. Diversify your portfolio – yet many seemingly diversified portfolios are really not
c. Style purity – restricting a portfolio manager to specific market segments (small cap, international, etc.) can lead to the investment equivalent of a hamstring injury in football. That is, the manager’s abilities are restricted due to lack of mobility.

5. Clipping…bond coupons – 15 yard penalty. The credit crisis has changed the bond game, maybe for a long time. Gone are the days where one confidently built a “care free” laddered maturity portfolio of high-quality corporate or municipal bonds. The bond market will likely return to its “old reliable” status again at some point. For now, however, low CD yields, suspect rating agencies and the general fear of risk in the bond market is akin to relying on a slumping place-kicker to win a game with a long field goal into the wind. It may work out but you are not as comfortable about it as you used to be. That should cause the resourceful investor and advisor to look for different ways to manage the conservative part of an overall portfolio.

Art and science

6. Illegal formation – 5 yard penalty. Thousands of people holds themselves out as “asset allocators.” We are one of them. However, asset allocation is an art and a science. It is not simply a neat computer program in the hands of an MBA, or a “target date” mutual fund that purports to tell you today how you should allocate your assets for the next 30 years. Those all sound good and look pretty, but may not get the job done

7. Too many men on the field – 5 yard penalty. We have read recently that the lack of trust in Wall Street will lead some investors to split their pot amongst several financial advisors. In our opinion this only works if you can truly identify the unique role played by each advisor in the total portfolio. Otherwise, you are just collecting advisors like coins or stamps (or stocks, as some over-diversified investors do).

Getting advice from too many sources often leads to uncoordinated advice, unless the client is willing to be their own investment “Quarterback.” As with football, in the financial game, Quarterback is the toughest position to play.

8. Offsides – 5 yard penalty. Investors probably feel that they have been on the “wrong side of the market” lately. The conclusion they reach is to either hope the stock market goes up, or sit it out until it does. Both approaches should send yellow penalty flags flying! A solution we have found that may cut investment losses and emotions, thereby keeping more players in the game, is to incorporate the use of securities that simulate short positions (which benefit from prices of a group of stocks or bonds going down) alongside their traditional “long” positions (i.e. buying something and profiting if it goes up). This is a portfolio feature that matters less when we are “on offense” – such as a long bull market. However, simply adding the potential to use the short side of the market when conditions demand it can insulate your portfolio like those portable heaters the players use on the sidelines during December games in Green Bay.

9. Roughing the passer – 15 yard penalty.

Taking it all out on your advisor (i.e., your “investment quarterback”) when they are trying to manage to your ultimate objectives. Time horizons and risk tolerance are serious stuff. Yet sometimes the investor profiling process is done formally, but neither the investor nor the advisor gets the most realistic picture of what the client’s specific need for risk management is. In times like this, an investor may be tempted to convince themselves to look for advice from new sources. Sometimes that makes sense, but often it’s one of those “grass is always greener” scenarios. In other words, it may appear that whoever the incumbent advisor is, they are automatically considered expendable. That’s when the client has to remember what drew them to their advisor in the first place, and whether those reasons are still valid. Often, they are. We could have called this one a penalty for “Unnecessary Roughness” instead.

10. Unsportsmanlike conduct – 15 yard penalty. Anyone in the investment business that provides advice not in the best interest of the client gets flagged on this one.

So, that’s “Investment Football.” While these “penalties” exist, as with football itself they are setbacks, not game-breakers. If you accumulate a lot of penalties it will make it tougher to win the game. However, if investors and their advisors work together to cut down on these progress-inhibitors, they stand a much better chance of the scoreboard turning in their favor. To do so, you must, as the pros say, “play 60 minutes” – no big letdowns, stay focused, be innovative and give your all on every play. For investors and advisors alike, that is the path to victory.

Robert A. Isbitts, a 25-year industry veteran, is a newsletter writer, published author, and investment strategist. He is also the lead-manager of asset allocation mutual fund and a global equity mutual fund. For more information on those mutual funds, visit www.easfunds.com. His second book, “The Flexible Investing Playbook” – Asset Allocation Strategies for Long-Term Success” was published by John Wiley & Sons in August, 2010.