Managing Your Investment Portfolio: Part Four
Economic Considerations
by Gerald Townsend, Financial Editor
April 2010
So far in this series on Managing Your Investment Portfolio I’ve discussed the necessity of setting realistic goals, judging your tolerance and capacity for risk and understanding how your time horizon, tax considerations and diversification needs affect portfolio management. This month focuses on economic considerations.
From the Dot Com implosion to the severe global recession of the past two years, headlines screamed about plummeting markets, rising unemployment, interest rates falling to near-zero, record budget and trade deficits — how is an investor to make sense of all this and develop a sensible investment portfolio?
I’ve often reminded of what Peter Lynch, the former superstar manager of Fidelity’s Magellan Fund, said in response to a question about his economic viewpoint. Lynch quipped that if investors spent five minutes a year trying to figure out the economy and gauging the future direction of the markets, that was about four and half minutes too many.
Does this mean global, political and economic developments are irrelevant in making investment decisions? No, but it does mean that while painting our investment portfolio upon an economic canvas, we shouldn’t allow the economic news of the day to either freeze us into inaction or stampede us, like lemmings off the cliff.
A year ago the economic statistics were horrible, and the talk was about how near we were to another depression. Yet, it was precisely at that moment that global markets began a remarkable recovery. This doesn’t invalidate the economic news, which is still not rosy, but it does point out the incredible difficulty of translating economic news into actionable investment decisions.
Economic numbers are often conflicting and confusing. A report about high unemployment might be followed by another report about rising labor productivity. The housing market is weak, but low interest rates are prompting refinancing and tax incentives are encouraging new housing purchases. How is an investor supposed to sift through all this data?
Economic numbers are also dated, backward-looking, and constantly revised after they are issued. We all tend to extrapolate these numbers, good or bad, in a straight-line into the future. However, as people change their opinions and actions, the economic numbers change. Economies are complex systems.
So, what good are all these statistics and forecasts? What should an investor do with all this data? How should it impact investment decisions?
First, accept the limitations of economic information. Treat it as informative, but use it to guide your decisions, not to dictate them. For example: The U.S. continues adding debt and running massive deficits while currently keeping interest rates very low. It is reasonable to anticipate that both inflation and interest rates will begin increasing. In that event, shorter-tem maturity bonds, adjustable-rate bonds or inflation-protected bonds appear more attractive than longer maturity bonds.
Second, don’t allow dire economic news or uncertainty to freeze you into inaction. People survive. Economies survive. Decisions still have to be made. Often, the worst decisions are to either do nothing or to do what feels most comfortable.
Third, utilize these limitations on the usefulness of economic information to spur you into focusing on what you can control. Diversify across various asset classes and investment approaches so that regardless of how the economy moves in the short-term your portfolio is not wrecked — and that, in the long-term, you don’t totally miss the boarding call when the economic recovery boat leaves the dock.
Gerald A. Townsend, CPA/PFS, CFP®, CFA® is president of Townsend Asset Managment Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com