What if You are Wrong?

Every time you make an investment in 2008, ask yourself the following question: What if I am wrong?

As we look forward to the next five years, we need to ensure we are always and everywhere operating with balanced ideas and temperament.

Our dialogue at Invest with an Edge starts and ends with the following: Having a Core Strategy and a Counter Strategy - just in case you are wrong!

One way we like to think about the capital markets and investing is the following: You can have a core set of beliefs, ideas, notions, and strategies. You can and would implement based on your core beliefs. However, what if your core strategy (or belief) is wrong, blows up, discontinues to work? In this case, you better have a back-up plan. That back up plan is what we refer to as a “counter strategy.” In some sense, this is the nature of diversification, but as you can guess, we do not believe in asset allocation and diversification just for the sake of it. Your core and counter strategy can still be opportunistic, and not spread out far and wide, because the far and wide asset allocation approach usually doesn’t stand a chance of beating the market over time and delivers mediocre results.

For example, you could be an aggressive investor, and your core set of beliefs is that we are in a day and age of progress, innovation, productivity…and you are going to build and design a portfolio that is technology heavy. It could contain semiconductor, software, and hardware type names…but maybe innovation also means biotech stocks, alternative energy, medical device companies, etc etc….these are clearly aggressive growth type companies, probably significantly tilted towards growth as opposed to value names. Bottom line, this is your core belief, and you hope to achieve substantial returns investing this way.

My question: what if you are wrong? Or, what if you are right, but wrong in the short term? The market has a nasty way of disappointing almost every investor, over time, and time and time and time again. Right? We’ve all been there. That investor better have something that might do well if his tech heavy portfolio lags, and that might mean owning financials, commodities, retailing, etc.

So, how should we address this situation in a simple way? The best way in our mind is to purposely mix a few specific strategies together in one global equity type portfolio. Let me address one thing – this is geared toward that 10% type long-term equity return. I am not taking into account fixed income, or a quasi balanced type approach. This is an equity only portfolio for funds earmarked for growth. There is a time and place for fixed income, but in this example, I am addressing the “equity return” objective.

Nonetheless, we combine an active sector, style and international rotational investing approach, with classic and longer-term/fully invested growth, value, and international funds so that we have the best of all worlds covered. First, it’s a global portfolio - we are neither taking a big bet for or against the U.S., or for or against non U.S. equity markets. Second, we run active rotational models as a core strategy, seeking to own what’s working and avoiding the laggards. However, our counter strategy is long baseline diversified equity funds – representing strategic & fully invested growth, value, and international asset classes. We think this type of portfolio stands the best probability to beat the market over time. All we are hoping to accomplish is that mythical goal of beating the market over time, and anything we can do to raise the probability that we can, we will implement!

They key point though, is that we are looking 5 to 10 years out, and we are willing to accept the volatility that comes with equity investing, and we make no guarantees or even statements about what the rate of return might be in that 10 year time frame. We will be subject to what the market serves up. Indirectly, it is a bet on capitalism and a bet that the equity markets will continue to perform better than bonds, enabling us to stay ahead of inflation and taxes. The key though, is simultaneously having core and counter strategies working for you at the same time.

Now, admittedly, there are numerous ways investors attempt to game the capital markets. However, that is precisely what makes the market tick! Also, some investors are faced with the limitations of the universe of funds available to them in retirement accounts or 401k type plans . In addition, this strategy is not a simple process - it is not easy to implement and to follow. It requires time and energy.

Therefore, one might think about a long-term portfolio that might look like this. S&P 500, MSCI EAFE, and a rotational strategy. The allocations to each are dependent upon personal circumstances and what not.

This is an important discussion for all investors and why I post it as my last post for 2007 - how to optimally manage a portfolio, especially since each and every one of us has some retirement objective in mind and some sort of lifestyle that is one day very important to us. If we seek to maximize our results against the benchmark, all the while considering that what we are doing could be wrong, then we will most likely succeed and our dreams will come true!

Good luck!

John