Investing: Welcome surprises

At a lunch I attended in New York last December, the experts were unanimous. The world oil price would settle in the range of $20-$22 U.S. a barrel. Absolutely no one foresaw the price subsequently rising to $30.

I cite this erroneous forecast as an example-not of how the experts can be wrong (they are human, too), but of how investing involves coping with unexpected surprises. Surprise can wreak havoc on the ill prepared and bring fresh opportunity for the properly positioned.

Add this element to jittery, push-button markets striving for new base levels and the V-O-L-A-T-I-L-I-T-Y can become extreme.  It can be even more unnerving when volatility storms blow through the markets with a frequency that seems to intensify each September and October.

This autumn was no exception, though nothing like the huge correction that a highly contagious Asian flu triggered on the world stock markets in October 1998. Such was the ferocity-and the accompanying panic-that Merrill Lynch’s stock plummeted from over $100 to less than $40 in a matter of weeks. That month’s client statements made for sobering reading, to say the least. 

Be prepared
&t;STRONG>However, if you were properly positioned and weren’t obliged to sell, it didn’t matter. It wasn’t long before those battered equity markets, and people’s portfolios, began rebounding strongly. Also, you could take advantage of the bargain opportunities presented by a correction of this magnitude. For example:

  • Buying Merrill Lynch shares at $40 before they rose back to more than $100.
  • An added bonus: Merrill’s shares recently split 2-for-1.

The lesson in highly volatile New Economy/Old Economy markets is obvious.  Be properly prepared, like the Boy Scouts-and ongoing surprises are to be welcomed-not feared.

My friends at GBC Asset Management define successful investing as:

  • A process of compounding (i.e. reinvesting) maximum dollar amounts in the most tax-efficient way, at superior rates of return, over long periods of time.
  • Warren Buffett, American financial advisor, summarizes it as “time in” rather than “timing” the markets. 

Proper set-up is key
Successful investing can be solidified by the appropriate allocation of assets between fixed income and equities, remembering that our circumstances are all different. After that, it’s giving careful attention to related essentials.  In the fixed-income section of portfolios, these would include:

  • Credit quality
  • Laddering (short, medium, long-term) of maturities 

In the equity section, it would include:

  • Sector weightings
  • Individual security selection

Proper setting up and positioning is so important, it can account for more than three-quarters of a portfolio’s subsequent performance. Believe me, this initial dialogue and planning is worth the effort.

Equities generate wealth
It should also be kept in mind that:

  • Bonds represent a contract to pay regular interest and the ultimate repayment of principal
  • Equities are the true generator of investment wealth. 

It follows, therefore, that selection of the ‘right’ equities-and related products like equity mutual funds-is critically important. Here again, what appeals to one investor may not appeal to another. Like investing itself, the choices can be personal, provided investors know precisely what they are buying and where their purchases fit within a well-structured overall plan.

Take market pulse
If this article sounds like a stuck record it’s because successful investing is a systematic, disciplined process of regular monitoring, screening and comparative evaluation. In other words, a process of constantly taking the pulse in order to:

  • Stay with friendly trends
  • Identify major turning points
  • Withstand and take advantage of surprises

A club manager I know and respect likes to be ‘positively dissatisfied’. It’s a state that could apply to all of us in our ongoing search for successful, surprise-proof investing.

This fall, I wrote about the challenge of coming up with that magic number-whether in total dollar or annual rate of return terms-that each of us should be targeting for our investments to outlast us. 

Looking ahead to the doubtless eventful new year, I urge proper positioning in order to bolster the attainment of our number, as well as to be able to withstand and welcome the inevitable surprises that will be encountered along the way.
Michael Graham, Ph.D., is president of the independent investment counseling and management firm, Michael Graham Inc.