Tuesday, June 15, 2010

Your 19th Nervous Breakdown

"Oh, who's to blame
That girl's just insane
Well nothin' I do don't seem to work
It only seems to make matters worse
Oh, please

You better stop and look around
Here it comes, here it comes
Here it comes, here it comes
Here comes your 19th nervous breakdown"
- 19th Nervous Breakdown – The Rolling Stones

Feeling a little queasy about stocks? Join the club. No one knows if they should zig or zag. Side with the bears or run with the bulls? Who knows?

You can probably shred your Risk Tolerance Questionnaire for the moment: I don’t know that you wouldn’t answer the questions the same today as you would’ve done before though, because a questionnaire is an intellectual exercise using “play money” if you will, whereas one’s true ability to tolerate risk in the moment is an emotional experience. [Notice the difference between "exercise" and "experience".] When markets are going down, we have a hard time imagining that they can or will ever go up. And when markets are going up, we have a hard time imagining that they can or will ever go down. There is far more pain in experiencing down markets than there is pleasure in experiencing up markets.

BUT - whoever said investing in the stock market was the only way to make money?

What you need to determine is YOUR Required Rate of Return. What % total return do you need to achieve to hit your retirement income targets? Is it 4%, 8%, 9.5%, 13% or __? If the conclusion is that you don’t need to achieve high returns in attempting to hit your target, then look for investment options that are likely to provide the return you need with a low expected deviation from that return. If a 4% return (for example) will get you there, then the stock market is probably not necessary.

Your Required Rate of Return is also dependent on inputs – account deposits and contributions (and these deposits and contributions do not have to go into tax-favored retirement accounts). The more you can add, the lower the return required to “get there” and vice versa. Think of the stock market as one tool in the toolbox – not the only tool in the toolbox. You can’t count on the stock market bailing you out with high returns in the future: the S&P 500 Index including dividends, had a negative return for the 10 year period ending Dec 31 2009.

Decide how much capital you are willing to risk, what level or levels of risk you are willing to accept, and put everything else in less risky positions such as bonds or an alternative like commercial real estate (which has different risk parameters than stock investing). You can buy real estate inside your IRA (with a plan document upgrade and the proper custodian) but there are trade-offs and limitations that make it less attractive than buying it outside a retirement account (in my opinion). For example, you don’t get to deduct depreciation. You also do not have to be the sole owner of commercial real estate – you can invest via a partnership or other investment vehicle.

Also, there is no rule that says all of your retirement capital has to be inside a retirement plan. The tax code encourages retirement plan contributions, but there is more than one way to skin the cat.

The stock market reflects human behavior, pricing the news of the day. Here’s the bottom line: what return do I need to achieve to meet my goals and what investments will capture that return? If the answer leads you to investments outside of the “easy channel” of the stock market, then that’s where you should go. There’s no rule that says you have to invest in stocks. If you find yourself running in a herd of lemmings, take a detour, find the road less traveled and change course.

Questions/Comments? kimm@sweetwaterinv.com

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