ARROYO GRANDE, Calif. – Cool it folks, as in: Don't get caught up in all the hysterical rhetoric about war. Yeah, yeah, I know it's all over the media, hard to miss. Seems everybody's beating the war drums lately, raising the fear level to code red with inflammatory reminders of the rise of 1930s fascism. Well, if there was ever a time to tune out the news, this is it. Or you might miss a new bull market.
Seriously, should war "chatter" ever have anything to do with your personal investment strategy? No! If you really want a winning retirement nest egg, your investment strategy better be based on unemotional economics and pure rationality. Why? Because when politics and emotions drive your investment decisions, you'll lose money.
You can't do anything to control the growing political rhetoric before the elections. But you can control your emotional reactions.
So ask yourself: What should your investment strategy look like today, if we go to war with Iran tomorrow? What should you do: Dump stocks and buy bonds? Short the dollar and buy gold bullion? Put cash under the mattress? Go contrarian and buy stocks? Or sit tight?
Fear rattles everyone's emotions, even those sitting with well-diversified, lazy portfolios. True, investors know these portfolios outperformed the broad market in the 2000-2002 collapse.
But as war drums beat louder, so do insecurities and the questions about a more conservative strategy. Last year we suggested three alternative defensive strategies in the event of more war. Let's take a fresh look:
Stay the course. If you already have a well-diversified portfolio, sit tight. History proves markets always come back. As Warren Buffett said in September 2001: "Whatever you thought about the stock market before the attack on the World Trade Center is what you should be thinking today."
Get lazy. But if your asset allocations are out-of-whack, get busy and build a solid well-diversified portfolio.
Go bonds. And if you're really panicked, consider the "nuclear bond" portfolio. Spread 25 percent each in four fixed-income funds: Vanguard Inflation-Protected Securities Fund (VIPSX) , Short-Term Corporate Bond (VFSTX) , Intermediate-Term Bond (VFITX) plus money markets or U. S. Savings I-Bonds.
This ultra-conservative portfolio was built on ideas in "The Only Guide to a Winning Bond Strategy You'll Ever Need," co-authored by Larry Swedroe and Joseph Hempen of Buckingham Asset Management. Swedroe's a respected financial teacher and author of "Rational Investing in Irrational Times."
With the war drums beating louder, I got curious: Is an all-bond portfolio really the best strategy? True, back in early 2000 MarketWatch economist Paul Erdman saw the coming crash, dumped stocks and went 90 percent into fixed-incomes. His returns were around 10 percent while stocks lost $8 trillion market cap in the 2000-2002 collapse.
But as Ted Aronson, the manager of $25 billion in pension money, once said about his own taxable portfolio: "I have no faith in my ability to time this sort of thing. Even if I got out in time, I probably wouldn't be able to correctly time getting back in!"
Impossible bull market, surprise again!
Swedroe told a fascinating story. First he painted a bleak reminder of the dark days in early 2003. You could feel the fear level rising before that massive shock-and-awe invasion of Iraq, with visions of an American city vaporizing in seconds.
Then Swedroe's story got even darker: On top of the nuclear threat, remember the mutual fund scandals? Enron? North Korea? SARS virus? The Palestine-Israel conflict? War in Afghanistan? Global deflation? High unemployment? Sustained domestic recession?
Yep, back in 2003 fear was flashing code red, far worse than today! "Almost no one forecasted a bull market in 2003," says Swedroe. In fact, most gurus were forecasting long-term returns around 6 percent, well below the historic 10 percent.
And yet, "2003 was the best year for equity investors in the last quarter century!" Domestic large-caps hit 25 percent, REITs and value funds topped 30 percent, international sectors soared to 40 percent to 70 percent returns.
The pundits were dead wrong! In those early dark days of 2003, an all-bond strategy would have been bad news. Your best strategy would have been a well-diversified lazy portfolio, offering both protection against the downside and opportunity on the upside. In fact, the top-performing lazy portfolio did return over 30 percent in 2003!
But if you're still an ultra-conservative do-it-yourselfer worried about more war, Swedroe recommends 60 percent Treasury Inflation Protected Securities and 35 percent intermediate-to-long bonds, plus 5 percent in a fund like Pimco Commodity Real Return (PCRAX) . TIPS protect the downside, while commodities play the upside. More TIPS if inflation worries you. More long bonds if deflation's your big fear. Keep only a minimum in money markets. Remember, asset allocations are highly personal, a function of risk tolerance, time horizon and available assets.
Rational or emotional investor?
Now back to the big question: How do you know whether you are a rational investor, or an emotional investor?
Answer: Rational investors will plan ahead, structure their portfolios today, well before another war, then stick to their asset allocations when (and if) the bombs suddenly start dropping. That won't eliminate your anxieties, but that's how to act rationally, reasonably and logically. And if you don't know what's best for you, get the advice of a pro, now.
But if you're an emotional investor ... you'll do nothing ... until after the action begins ... then react. Except then it'll be too late. That's irrational — unfortunately too many investors fall in this category ... waiting ... wondering why they're losing money.
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