April 2015

CapSouth Investment Update

In this commentary I’ll provide the best investment advice that I can give you! If you attended our Economic Forum last week, some of this may sound familiar as I expand on comments made there. But first I’m going to follow-up on the diversification discussion that was the primary topic covered last quarter. 

As was stated in the last commentary, we diversify accounts and portfolios because we (nor anyone else) can say with any degree of certainty what areas of the market will do best and worst in the short term. Historically, diversification has reduced volatility while leading to similar returns. During short periods though, diversification can actually hurt results; we experienced such a scenario in 2014. We’re already seeing a reversal of this in 2015. The S&P 500 type stocks, or stocks of larger U.S. companies, were some of the worst performers in the first quarter. While the S&P 500 was up nearly 1%, small U.S. stocks were up over 4% and developed international stocks rose about 5%. While we have no way of knowing if this trend will continue throughout 2015, it does illustrate why we continue to be diversified by holding smaller company and international stocks. We cannot say with certainty what area will perform best over the next year, but we can say with certainty that sometimes international will lead, sometimes smaller companies will lead, and sometimes larger companies will lead. No one area will continue for a long period to outperform the other areas. So given these facts and the historical record of diversified portfolios, we’ll continue to stay with this tried & true strategy. 

Now to the best investment advice I can offer . . . develop a long range financial plan and investment strategy then give it time to succeed. Sounds really simple, but let’s dig into it a little further. 

Developing a plan is critical to your financial success. Without a plan your long term financial goals and dreams, whether they be retirement, buying a vacation home, funding charities, etc., are all undefined and it becomes difficult to know if you’re on track to accomplish them. A plan takes an inventory of your current financial resources, looks at where you want to be in the future, and then sets a strategy for getting there. Part of this strategy is a risk level for your investments; by doing the planning work we have a much better idea of the amount of risk that needs to be assumed in order to maximize the chances of realizing your financial dreams. Without a plan we’re just taking an educated guess as to what level of risk is appropriate. 

The other incredibly helpful aspect of having a plan in place is that it keeps all of us focused on the long term. Decisions are then normally driven by periodic reviews of the plan – we may need to address a change in goals or recognize that we’re ahead or behind where we should be in order to meet an already established goal. One of the options at this point, among several others, is a change in the investment risk level (also called a portfolio change in CapSouth lingo). In my opinion, changes in risk level that are dictated by the financial plan are optimal because they’re normally well thought out and are done with a focus on long term success. 

I believe one of the greatest deterrents to building a plan and staying with it is the constant barrage of financial data that surrounds us. Among other things, we have daily access to investment account values, multiple TV channels devoted to financial news, and numerous investment and/or market related websites. All this information feeds our emotions and often leads to a desire to act. The action taken is usually based on these feelings and not based on long term planning, and it is often detrimental to the financial plans and goals. Over the last 20 years or so an entire field of study has arisen around this issue 

– behavioral finance. At this point it is well documented that our emotions normally lead to decisions that are exactly opposite of wise investment counsel. I’m not saying you shouldn’t ever check account values or that you should stay oblivious to what happens in the investment world. This is more a word of caution that if all this information starts causing fear, greed, or any similar emotions and this leads to a desire for action, we need to pause and carefully consider the consequences in light of our long term goals. 

I’ve touched on the most common occurrences of this in prior commentary but feel it is worth the time to mention them again. When the market begins any type of sustained drop, it is common for investors to become nervous or fearful. The reaction is usually a desire to sell; I saw this over and over in late 2008 and early 2009 as stock markets around the world stumbled. The converse is also true. If the market has consistently risen over a period of time, we often feel more comfortable and are more willing to jump into it or take more risk. In the late 1990s the more technology stocks went up, the more people wanted them. Real estate, whether real property or stock related investments, was a similar story in the mid-2000s. Currently U.S. stocks have risen for several years. It’s at times like these that we hear many stories of people making a lot of money, and we want some of the action! 

Having a financial plan in place and basing actions on the plan would tell us just the opposite things though. A plan would usually show that if returns have been abnormally high for a while, we may be ahead of pace in reaching our goals so that a risk reduction should be considered. Alternately, if the market has been in a period of low or negative returns, we may be behind in reaching some of the goals and should consider increasing risk. Of course this is exactly in line with the maxim of “Buy high and sell low.” Warren Buffet, considered one of the greatest investors of recent times, says is this way, “Be fearful when others are greedy and greedy when others are fearful.” 

A longer term time frame is integral to all these thoughts. If your time frame is greater than 5-10 years or you will not need a large portion of your investment assets during this time, it really does not make much of a difference what stocks do this week or this year. If they are negative, there should be plenty of time to recover the loss in value and even see further gains as the market rebounds. Supposing you have a shorter time frame then stocks are probably not a good option or should not constitute a large portion of your investments. In this case it also will not matter how the stocks markets perform over the next few years as your assets should be in safer, more stable investments. 

So to wrap this up, a well thought out plan is one of the greatest tools you can have in helping to ensure that your financial goals are met. It provides a roadmap and keeps us focused on the long term results as opposed to the short term noise, or ups and downs in the market. Acting on emotions caused by the noise is potentially one of the greatest detriments to meeting your long term goals. So if you haven’t done so already, build a financial plan and set an investment course based on the plan...then give it time to work and base any changes on the periodic status checks of the plan. This advice is worth much more than any hot stock tip or great investment idea I can provide. 

Although my primary role is on the investing side, as you can tell I’m a huge advocate of basing the investments on a financial plan. If you have any questions regarding financial planning, please let me know. I’ll be able to answer most of them, but if needed I’ll have someone in our firm who specializes in planning contact you. As always, thanks for the trust you place in me and CapSouth! 

Marshall Bolden, CFA
Vice President, Chief Investment Officer