SunLakes of AZ Blog

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February 2017

Keep Your Financial Investments Focused During Difficult Economic Times

by Karl Schroeder for Finance

Nobody knows for sure when it will all end. The one thing we do know for sure is that these are very stressful times for all of us.  It is hard to take a long term view and stay positive in this environment of raw fear and uncertainty.

The selling of the last two months has been surprising in its intensity, and may have challenged your assumptions about market risk in your portfolio. We have had conversations with lots of folks over the last months, and each has been different yet the same. How low will the market go? Will I have enough money for my retirement? Should I do something now?

It’s extremely important to put your portfolio design into context with your goals. Each person’s goals and situation are different and so each portfolio must be considered unique as it relates to their situation. Is your portfolio designed to provide income for a lifetime?  What is the timeline for my goals?

Each goal brings with it certain financial assumptions and requirements. Lifetime income must be considered along with what we know about inflation and the spending needs of those living in retirement. Shorter term goals may be more influenced by current savings rates than by portfolio returns.

No matter the goal, there are a limited number of investment areas in which we can participate with the savings and investments we dedicate to those objectives. While the investment universe is incredibly complex in regards to individual investments, we can reduce the clutter by combining them into 5 major asset classes; cash, bonds, stocks, real estate and commodities. Each of these have their own unique characteristics and each are suitable for investment portfolios depending on the particular goal for the portfolio.

Cash (and cash equivalents) are the most stable asset class. These are savings accounts, money markets, short term CD’s, T-Bills etc. This stability comes at a price. These investments usually do not exceed inflation over time, and many lag inflation. This gives them a longer term real return (after inflation) of zero or less and makes them appropriate for short term goals, and not appropriate for longer term goals dues to their low or negative real returns. These are the assets that people use over time to “go broke safely”.

Bonds are IOU’s of corporations and governments. While their interest rates or yields tend to be higher than that of cash equivalents, their prices can fluctuate more as well. Changes in interest rates, changes in the stability of the issuer and expectations of economic growth can all affect their price. Since bonds are “IOU’s” they often have a claim on the assets of the issuer, making them more conservative than stocks in general. Longer term bonds (depending on the price for which they are purchased) are expected to have real returns that are positive over time.

Stocks represent fractional ownership of corporations. As such their owners participate in the fortunes of the issuing company. The risk of individual companies can be mitigated by owning the shares of many different firms. When looking at the aggregate of various combinations of stocks we can measure the average returns and price movements over time. Stocks can be extraordinarily volatile over short periods (as we have been reminded of late), but more predictable when held over long periods. Stocks over long holding periods have historically had substantial real returns, and as such they are included in portfolios designed for long term growth and income when there is a need to protect against inflation.

Real estate can be owned outright or in combination with others. Similar to stocks, real estate can deliver substantial real returns over time. In the same way that stocks can fluctuate based on economic outlooks and other expectations, so too can real estate fluctuate in value. Because most real estate does not trade on established markets (like stocks and bonds do) its fluctuation of price is not as noticeable over short periods. One can invest in the stocks of real estate management companies (REIT’s) as a proxy for the hard asset in investment portfolios.

Commodities are “things” and just as the values of things are influenced by inflation so are the values of commodities. Historically over longer holding periods a diversified basket of commodities will have positive real returns. The price movements of individual commodities can be very volatile. Their use in an investment portfolio is often desired because their price movements tend to be different than that of stocks and bonds, providing potential reduction of price volatility in the portfolio as a whole. Gold and silver have value as commodities and as financial instruments as well.

Which of the 5 investment categories should we use for our portfolio? Should we use one or all? The need for stability of principle, inflation protection and return will dictate which asset classes make the most sense from a historical perspective. And there are other considerations as well. How we combine our asset classes will have an effect on the portfolio as a whole. Spreading our eggs among different baskets can ease the effects of various portfolio risks as well. Cash for the short term, bonds for current income and stocks for longer term growth can help to create a portfolio that addresses different portfolio requirements.

A bear market is always a not so subtle reminder of market risk, and what that means in dollars and cents on our monthly statements. This particular bear has been more marked than many for a number of reasons. The rapidity of its unfolding, the sheer size of the drop in stocks, real estate and commodities and the accompanying economic woes of the financial system have made this a memorable market to say the least. Many people are re-thinking their tolerance for risk motivated by the fear of this most unusual situation.

Our job is to help you reach your long-range financial goals with long-term investment strategies. However, some clients are realizing that they are far more risk adverse than they had previously thought and they want to make a change.  Their focus has shifted from their long-term goals to their current stress level.  And that is very understandable.

It may be useful at a time like this to mentally convert your portfolio to cash. If this were the case, and given your recent experience along with what you know about the behavior of the asset classes we described above, which would you choose for inclusion in your new portfolio?

Would it make sense to buy stocks now with prices as low as we have seen in many decades? Do bonds make sense given historically low interest rates? Cash equivalents are attractive to many because of the stability but with interest rates this low will they provide the needed return for a long term goal? Is preventing future account declines your primary criteria? Do you want current income in today’s dollars, or future income adjusted for inflation? Or both?

The process of developing a portfolio strategy involves many factors, and for most portfolios the ramifications of our choices will stretch far into the future. These future goals are absolutely essential to consider in any portfolio design/redesign. What are your goals and what are the other criteria that must be considered? Do you want to reduce volatility and the stress it causes?  Do you want current income in today’s dollars, or future income adjusted for inflation? Is taking care of yourself a higher priority than leaving an inheritance?  Is avoiding further declines more important than all other goals? Do your criteria apply to all of your accounts or just to one or two of them?

We believe that our clients should stay the course, as hard as that may be. Of course we are always willing to help you assess your situation and analyze your choices.

Please feel free to call me. Know that I am very grateful for the privilege to advise you in these difficult times. And yes, we will get through this.


Karl Schroeder, RFC

Schroeder Financial Services, Inc.
9666 E. Riggs Road, #136
Sun Lakes, AZ 85248

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