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Don't worry. Be happy. Here's why…

Sometimes, investors are their own worst enemies. In conversations with my portfolio management peers, mutual fund managers, clients and subscribers of late, to a person, the professionals, as well as most of our clients and subscribers, are befuddled by the aimlessness and/or freneticism of the average American investor these days.

Absent the emotionalism, investing isn't rocket science: if an investor has a clear understanding of their goals, they can select an appropriate strategy to reach those goals, and hew to a disciplined approach that keeps them on the straight and narrow. It really is no more complicated than that. There are numerous strategies that allow you to reach any goal, so it isn't terribly difficult to select one that fits each investor's personality, temperament, risk profile, time horizon and assets. The hard part is the discipline.

Think of the tortoise and the hare. Hares can make money - at least in the short term. People who jackrabbit about, buying XYZ in the morning and selling it in the afternoon, vowing to mimic the big Wall Street trading desks that strive to reduce risk by closing all positions before the close and re-initiate them, or others, the next day, might be successful. Certainly, when they are lucky enough to ride a bull market that happens to go up, up and more up (as we've seen lately) they will not only make money, they will think they are brilliant. If they write a newsletter or newspaper column, they will let everyone know just how brilliant they are!

Genius is a rising market.

But over time tortoises tend to do far better. They do better with less trading, less risk, less short-term returns, but better returns over more than one market cycle. Tortoises just keep plodding along, making their fair share of mistakes but, over any reasonable time frame, doing more things right than wrong.

Many investors say they want to preserve capital and seek solid income with conservative growth - but that lasts only until the second or third 100-point day up and then they are clamoring to their advisors or pulling their money out of the mutual funds that "can't keep up." So then they are in a new fund, or with a different financial advisor, because they want to be part of the "action" - but this lasts only until the second or third 100-point down day and they are berating the fund or advisor for losing all their money!

Emotional swings between fear of losing money and greed (or fear of not making money) have always been the hallmark of most investors. That's why study after study shows that most investors in mutual funds never do as well as the funds in which they are invested. That's because they decide when to jump in or out of the fund based upon a scary news headline, a down day, a tout by some financial writer, an up day, a hot tip from a co-worker who knows a guy who knows a guy about some speculative can't-miss frontier market mining firm, the price of cheese in Limburg, or a transmission received on their orthodonture from a distant planet. But it is the short attention span that I hear my fellow professionals decry the most. It used to be these mood swings would occur over a few months; today it can be as little as a few days.

Many roads lead to Rome, where Rome = where you want to be as an investor. Allow me to provide at least one alternative to the pell-mell scattershot approach above.

This particular strategy stresses safety and steady performance. Few fireworks; just results. I wrote the words below to two of our clients recently re their all-too-common concern they might be "missing something" by being prudent, wanting to stress preservation first, and having a reasonable diversification between equities and fixed income...

"Too many investors fail to comprehend the sublime mathematics of this protective course of action. If the market is up 20% in one cycle but, because an investor needs to protect what they have, they are "only" up 10%, they despair. It is little consolation to them that, when the market goes down 20% the next term, they are down only 10%. They think it's all the same: up 20% then down 20% leaves one in the same place that being up 10% and down 10% does. Not true!

"It is worth taking a moment to graphically illustrate why this income + growth strategy works best for you to reach your goals, which you can see in the chart below."

(click to enlarge)Up 20

* The 'winner' for this particular term / 'winner' also in green, straggler in red… © Stanford Wealth Mgmt LLC 2013

Safer is actually better: A portfolio that includes both fixed income and equities will, of course, underperform in rip-snorting bull and piggish markets, but will protect from the bear when the cycle turns. And over just a few cycles / terms that approach will soundly thrash those who take greater risk.

In the example above, for every $100,000 invested, an up term (a quarter, a year, or any other time period) of 20% becomes $120,000. The 2nd (down) term, however, removes 20%, not of $100,000, but of $120,000, leaving $96,000, less than what one began with. It's the same with the less volatile approach that is less satisfying in up markets, collecting dividends and income, but making just 10% returns each cycle: that portfolio increases to $110,000 the first term, and falls to $99,000 the 2nd. However -- this approach will always prove less terrifying and ultimately more profitable.

You'll notice that, in each succeeding term, that level of protection in down markets actually allows you to out-perform the market-following strategy by the end of the 5th cycle, an up-cycle in this example. From Term 6 on, the rabbits continue to dash forward when the market is up but then fall back, panting, while the turtles move farther and farther ahead.

Whether a "term" is 3 months, 6 months, or a year, the results are the same: this less risky style of portfolio management lets you sleep better during any market, you are less likely to be panicked out at the wrong time, and over the long term you increase your net worth much more than the person who seeks to index the market.

Additionally, you can add additional incremental performance by…

Reallocating portfolio assets via trailing sell stops, covered calls, sector rotation, etc. in frothy markets, and puts, buy stops, sector rotation, etc. in weak ones.

Selecting sectors and companies that out-perform for the equity portion of your portfolio.

This more conservative approach addresses risk first, reward next. If you are diligent about diversifying across asset categories, markets, and sectors, you can earn smaller returns in any one term - but larger ones in the aggregate. And with less stress.

THE FINE PRINT: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.

We encourage you to do your own research on individual issues we recommend for your analysis to see if they might be of value in your own investing. We take our responsibility to proffer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we "eat our own cooking," but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about.

Source: Afraid You've Been Too Conservative And Missed The Market?