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Are You A Carousel Or Coaster Investor?

Historically, in the Midwest and Northeast, Memorial Day weekend has been the kickoff for amusement park re-openings. From rollercoasters to merry-go-rounds, the plunges and whirls begin in earnest with the unofficial beginning of summer.

Most of the kids I know can't wait. The pleading with mom and dad to take them starts in early May and continues all summer long. Hereabouts it's a last month of school ritual for the teenagers to skip a day and head to Cedar Point or Michigan's Adventure amusement park.

The allure of amusement parks seems universal. Disney and others have exported the concept worldwide, and the crowds just seem to grow year after year. According to the latest Statistical Abstract, (2012), in 2007 there were over 1,300 amusement parks in this country generating over $13 billion in annual revenues.

Because of the success of Disney, Universal, and Six Flags, I'm sure many think of amusement parks as American inventions. Yet the concept goes back to the 1500s and the fairs of Europe. Still, Coney Island in New York City (although Vauxhall Gardens in New York predated it) was one of the first fixed venues, and was the popularizer of the rollercoaster, perhaps the biggest young adult draw for the last 100 years at the parks.

I think amusement parks are so popular because they have something for everyone-no matter what their age. Whether it's just a walk around the park's attractions or a ride on the latest, greatest coaster, there's something to satisfy everyone.

But not everyone is able to cope with all of the rides. For some, the merry-go-round is all they can stomach, while others line up over and over again (with a VIP speed pass, no doubt) for the Demon Drop!

In investing, most people think they know what will satisfy them. Usually, it boils down to an investment with high returns and no risk. Of course, such an investment does not exist.

As investors become more aware of the true opportunities open to them, they learn that risk and return are tied together. Less risk usually means lower return.

They also learn that not all investors are alike. They do not have the same appetite for either returns or risk. One investor may have no problem stomaching declines of 50% or more, while most max out at 20% and a large number are still nauseated by a decline of 10% or less.

As a result, most investment firms offer core, suitability-based strategies. At Flexible Plan Investments, we have seven. Typically, these strategies come in three to five flavors. Portfolios labeled Conservative, Moderate, and Growth are the usual three, with the five-choice variety adding Balanced and Aggressive to the mix.

If we think of this in amusement park terms, it would equate to:

Conservative = Merry-go-round

Moderate = Ferris wheel

Balanced = Train ride

Growth = Dodgem cars

Aggressive = the Wild Mouse

(Note at Flexible Plan, and at most active management firms, we try to avoid rollercoasters when it comes to investing!)

The advantage of these suitability portfolios, like the variety of rides offered at the parks, is that they seek to match the investor's (the rider's) appetite for risk. Each tries to deliver the highest returns for the perceived level of risk being taken.

While this means that the risk of the ride is matched to the rider's ability to withstand the risk, in the investment world, like at the amusement park, the level of returns will vary-normally, the lower the risk, the lower the return. The rider on the merry-go-round generates less screams of joy than the rider on the rollercoaster; although on the carrousel ride the number of heart-stopping plunges is non-existent, while the coaster fanatic will experience many.

It's important to remember that investment suitability changes over time. Just as you may have loved the rollercoaster when you were in your teens, your ability to take its twists and turns, climbs, and plunges may have changed when you reached your senior years.

Each investment firm's Suitability Questionnaire is the vehicle for determining your level of risk suitability. Whenever you believe there is a performance problem with your investments, it is a good idea to retake the questionnaire to see if your true appetite for risk has changed while your investment portfolio has not.

And, of course, the realization that a Moderate portfolio with limited risk is not going to perform as an Aggressive portfolio helps a lot in balancing your return expectations with the risks that are truly acceptable by you. Failure to do this is like putting an aggressive thrill seeker on a merry-go-round or a conservative rider on a rollercoaster-nobody will be happy: the former will be bored and the latter will spend the rest of the day throwing up.

As we close the books for May, the results resemble a patch of track on a junior rollercoaster; we ascended a bit over 1% on most indexes (over 2% on the NASDAQ) for the month but took a mini-plunge last week as the S&P 500 tumbled 0.88%.

Just as each ride is very different at the amusement parks, we saw a wide range of returns among investable assets in May. While domestic stocks rose, long-term Treasury bonds fell about 2%. Many agricultural and energy-related commodities declined over 3%, while the precious metals sector saw gains. Interestingly, with all of the talk about the relative attractiveness of international investments, all US major stock market indexes increased in value in May: 12 of the top 16 country index ETFs fell as did the emerging market indexes.

As mentioned, bonds tumbled last week meaning interest rates headed higher (as earlier forecast), and that's a negative for stocks. However, while earnings season has ended, analysts' earnings revisions continued and there the trend is higher, which suggests higher stock prices as well. Sentiment continues mildly positive as there appear to be few bulls, despite recent market highs, and even fewer bears (according to the American Association of Individual Investors' survey).

Our friends at Bespoke Investment Group have put together an interesting assortment of seasonality statistics this month. While June has not been a great place to invest (especially after the 19th over the last 20 and 50 years with gains only about 45% of the time), it's interesting to note that when the market was up in May and up for the year to date as of the end of May (as has been the case this year), stocks were higher most of the time in June.

Source: Bespoke Investment Group

And despite the fears of high valuations (high price earnings [P/E] ratios) in the market, when both of those seasonality conditions existed and the P/E ratio was at least 19 (where it now stands), the S&P 500 was up over the subsequent June, June through August period and, even over the rest of the year, for that matter, seven out of the nine times that condition has existed. In fact, as Bespoke concluded, "the S&P 500 has actually done better in Summer months when it was up YTD and in May with higher valuations than it has compared to periods with lower valuations."

With the primary trend of the stock market still positive, it would appear that we are still on the ascending part of the Ferris wheel. That's great for most of us, but if you are afraid of heights, consider ratcheting down your suitability profile until the ground does not seem so far below.

All the best,

Jerry