The Fed May Get It Wrong, But Don't Let It Get to You

OK, show of hands: Who thinks the Fed has been out in front of the financial crisis, accurately calling the various twists and turns in the economy and, by extension, the capital markets?

(Imagine the sound of crickets chirping in a field).

I got my hands on a report from Merrill Lynch that noted Bernanke's conceded contraction was likely and growth may be slow to start up again. So assuming I am correctly interpreting Merrill's interpretation, this makes for an interesting talking point.

Whether it is politics or something else, any sort of government body is always late to acknowledge problems of any sort, and always tries to put a positive spin on things as long as possible. Well that's my opinion anyway.

So following this line of thinking, the Fed will understate the magnitude of the downturn in its comments and possibly its policy. Does this mean that whatever Bernanke said in his testimony is wrong in terms of magnitude and we should prepare for worse?

He was clearly wrong last summer about what was going on, how about now? I don't know.

In terms of managing your portfolio it doesn't have to matter. The way I view the world, demand for stocks is either healthy or it is not, regardless of the reasons. When demand is unhealthy, like now, some sort of defensive posture is prudent. When demand becomes healthy, again, the defense much becomes less important.

Whether the bottom comes 50% from the top or is already in, doesn't have to matter with a disciplined exit strategy with a decent track record, that hopefully doesn't trigger every few weeks. If you really can think about performance over the course of the entire stock market cycle, then the goal of being down less will resonate.

This is not easy, especially if you have not thought in these terms before, but if you don't need the money now, then you don't need the money now. If you do need it now, then you have made a bad asset allocation decision. John Hussman built a $3 billion mutual fund on this concept and I can recall comments left on this blog taking shots at Hussman's performance that I believe did not understand the goal.

A fifty year old saving for retirement at a normal age does not understand the goal if he has been freaking out over the last few months.

Comments

[ericinNE]

In as much as "freaking out' is never a useful response to any bad situation, a fifty year old saving for retirement at a normal age (62), who needs a 15% year-on-year return for the next 12 years (to have the kind of nestegg that can be seen as "insulating"... i.e. me,) definitely has cause for concern. The odds of 15% (as a reasonable expectation) have become much less likely, and not just for the next few months. More likely not for the next 5 years. Depending on the depth and length of this current downtrend, the need for truly stellar returns in the remaining years after the recovery becomes more and more necessary, and at the same time less and less likely. As much as I would love for it not to "get to me," it does. Big time. I have no illusions about risk/reward ratios and the like, but lets face some facts, here.Those who have had the time to build their nestegg, and are now in conservative mode (already retired,) and those that have a much longer time horizon to recoup from this sort of protracted lower-return market (the young) are in a whole different world than the group you seem to be addressing this article to. It is exactly that "50ish" group that is going to have sweat this cycle the most. Having a significant portion of the current nestegg devalued to the tune of 15%-50% (their home) with no real expectation of recovering much of it by the time they retire doesn't improve the attitude much, either. The recommended defensive posture must, by definition, be more concerned with capital preservation, than with capital growth. And this deflection from capital growth is coming at the very time when the pursuit of that growth is at it's utmost: when reasonable-return expectations are at the low end of the reasonably-attainable spectrum. Unless, of course, you're starting with so much that 6% or 7% returns are within your reasonable-return framework.

Scenario: $280,000.00 starting balance (IRA's)
$ 8000.00 yearly contributions
15% return for 12 years (until age 62)
8% return thereafter
$1.73M nestegg @ age 62
$1.27M projected inflation value (based on last 12 years real inflation rate- per shadowstats.com)
$85912/yr. after-tax drawdown to age 90 (inflation adjusted, 25% tax rate assumed, and that's probably laughable.)

No doubt this should be able to provide a comfortable lifestyle, but by no means would I call it a wealthy lifestyle. Merely "insulated."

If the rate of year-on-year return drops to 10% for those first 12 years, the after-tax drawdown/yr. drops to $52,132. Enough to do some occasional traveling, eat normal food, and that's about it. Not what I had in mind for my retirement years. Ah, but what the hell. That comet will probably hit the "keyhole," and come 2029 it all won't matter, anyway.

[RogerNusbaum]

I hate to say this but the odds of averaging 10% are quite low and candidly 15% is a HUGE long shot even during a good period.

If the market averages 10% then 15% would be an average annual beat of 5%. How many times have you beaten the market by that much and your plan looks to do that every year for 12 years?

I am very sorry to say this you need a different plan.

[ericinNE]

I wish I could have a different plan. Re beating the market average: done that every year since I started actively investing, the last 5 years. Have averaged 22%, but that was, of course, during the last bull run, and being totally invested in emerging markets. Not sure how you came to the conclusion that beating market averages of 10% is hard, unless your risk tolerance is way lower than mine. My point was to the fact that it's the 50ish crowd that is going to have the hardest time in this downturn cycle, especially if the cycle is longer and deeper than is being currently hyped as the "most likely" scenario. Which I don't buy into. Appreciate the response, tho.

[AccuFundTrader]

15% is doable, even in this market. Start by protecting the bulk of your portfolio from negative returns. Take a look at some Absolute Return and Conservative Asset Allocation mutual funds such as (PRPFX, RYMFX, HSTRX, TFSMX, EXDAX, and GLRBX). I own the first two myself, but I haven't done any in real research other than looking at holdings and historical price movement (especially during down markets). When comparing funds be careful when looking at charts. Many charting services don't adjust for fund distributions with any regularity. What you'll see in the charts usually looks like a large price drop every December, which is usually a large cash distribution or reinvestment. Morningstar is a good place to look for fund info (news.morningstar.com/f...=$FOCA$TB). The funds you want will typically fall into one of the following Morningstar categories: Long-Short; Conservative Allocation; Moderate Allocation; World Allocation.

Then for a smaller portion of your portfolio look to something more aggressive using an Absolute Return strategy. This portion of your portfolio will earn a better return (hopefully, 20%+ annual) and with compounding, will grow to be a larger portion of your total portfolio over time. As it grows larger you can rebalance as you wish to keep it on track to meet your retirement goals.

If you want to talk more, you can get in touch through this page: www.accufundtrader.com...

[AccuFundTrader]

I noticed that my link (above) to Morningstar got cut off, so here it is again split in two pieces:

news.morningstar.com/f...
/FundReturns.html?cate...