Jim'sMoneyBlog

Financial Opinion and Insights

The `Downgrade’ is Old News

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Last Friday’s jobs report looked good on the surface –  over 100,000 jobs were created – over 200,000 people left the workforce and there have been over 200,000 net job losses over the past two months at a time when 250,000 new jobs are needed each month just to break even.  So, it’s still too early to pop the champagne.

While arguments continue in the media over the causes of the current gyrations, my guess is the credit downgrade by S&P isn’t one of them.  After all, not only was the downgrade telegraphed well in advance, but frankly, credit is what it is, regardless of the label provided by a discredited third party, and institutional investors – the biggest buyers of bonds – know what they’re buying.

The bigger `boogie man’ is the underlying issue:  Government debt and the desire to continue spending to add more.  And, the other shoe just may occur in the municipal bond market as municipalities across the country face the music brought on by their own spending.  The same holds true for states like California, Minnesota, and plenty of others.

Maybe the markets have been voting on the government’s ability to manage our money – after all, it is done by committee; and a large one made up of largely of lawyer/politicians, at that.

What should investors do?  Maybe nothing.  Reacting to  news has seldom, if ever, proven to be a sound strategy.  For those still working and contributing to 401(k) plans, this market is very likely a blessing since they can buy more cheap shares on sale for the same money.  Likewise, those not needing to tap long-term investments for living expenses will likely see little long-term effect, provided their allocations are well designed (see below); the Rip Van Winkle pill should work. 

The real impact of stock market gyrations, of course, is on those who need to live on retirement income from their investments.  Few of these people, depending on their financial plan input, probably shouldn’t have a greater than 20% allocation to equities, anyway – a statement of opinion requiring greater explanation than a blog post would permit.  Nevertheless, this is one of the reasons having the proper allocation is so important:  A 40% loss on a 20% allocation. For example, would result in only an 8% impact on total portfolio value, provided values in the 80% bond portion of the portfolio don’t change.   Bond values do change, of course; but, those with short-intermediate bond positions in a separately managed account, are largely unaffected since all bonds in the portfolio can mature at face value, rendering interim price movements moot. 

But, whether in a separately managed portfolio of individual securities or a mutual fund, active management on the bond side of a portfolio doesn’t add much to the expense side and does allow for the potential to manage interest rate risk, something that’s problematic in an index fund or ETF.   Longer term, properly allocated inflation hedges may prove more worthwhile in virtually all allocations.

So, for those with updated plans and allocations, the current market gyrations may likely have lesser impact than being advertised on the media, as well as little long-term effect on reaching overall goals.   Those without a plan or a strategic long-term allocation may find themselves getting ‘whip-sawed’ by the market – selling on emotion (when the market’s down) and buying back in when `confident’ (at a top).  Not a good way to manage money.

Or, if you want to manage money like the government, you could always borrow!   Naaaaaah.

 Jim

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NOTE:  Jim Lorenzen was interviewed by The Wall Street Journal’s Glenn Ruffenach for an article appearing in SmartMoney magazine.  You’ll find it on page 46 in the September 2011 issue now on newstands.

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and an Accredited Investment Fiduciary®  in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

August 16, 2011 at 7:10 am