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When is it Time to Switch Investment Strategies?

               At some point in time, investors ask themselves this tough question. It’s understandable considering how much emotional currency we place on our own perceived success or failure with investing. Did I have a good year with my investment? Tough question. Relative to what? The markets? My own goals or design of my portfolio? My expectations? What my friends say? What CNBC says? No wonder, we all feel that sense of anxiety about how we’re doing and whether we should change investment strategies. There are clear answers to these questions for mature investors who understand markets and themselves. Let’s dive in.

What do we mean by investment strategies?

               In our shop, we actually tag our individual investment portfolios as “Strategies” because that’s what they are. Each offers our clients a different approach or driver of return among the available market of securities. Some are focused on stock only strategies, others are bond or income only, others are diversified blends. Others might define a “strategy” as a passive approach, effectively buying and holding a blend of free-to-own index funds. Different investors might stick with a more active “strategy” like traders, stock pickers or those who dynamically allocate their investments depending on market conditions.

The Rules for Strategy Changes

1. Never, Never, Never

…. Chase returns. Without a doubt, this is the most common, most frequent and most devastating type of strategy change that I see among investors. The drive to chase returns comes from our very human, emotional need to be all that we can be and associate with winners, not losers. I’ve heard investors ask why a diversified portfolio of bonds is not keeping up with a single stock like Google or Netflix? The “strategy” change for the return chaser is the moment when the investor finally capitulates and sells all things that have underperformed and then compounds the error by putting the proceeds into things that have already experienced enormous gains. We call this selling low and buying high, the number one error in behavioral economics. Rarely does this type of change work out for the chaser. 

2. Change strategies as your life changes, not because of market expectations

  • Again, we would urge every investor to build the right portfolio of investments and appropriate asset allocation based on the financial status and emotional temperament of you and where you are in your life. Variables that influence your portfolio construction are as follows:
  • Your risk capacity – how much volatility can you handle (really)
  • Your income versus debt - How much can you save every month?
  • Your current wealth and assets – more than you need or living hand to mouth?
  • Your age or time horizon – Are you living off your accounts now or don’t need the money for 20 years?
  • Life Transitions – Retirement, inheritance, divorce, and death

These are the big ones, and these are the only inputs that you should consider in your current investment “strategy”. When a 75-year-old, retiree comes to me and says, I want to be more aggressive after a year like 2019 and asks what changes we should make? I ask a common question in response;

What has changed in your life that would allow you to become more aggressive now?

I would pose the same question to any and all really. What life change have you experienced that suggests a strategy change is in order. Of course, life does change, and we do have good reason to increase our risk and return prospects like a new high paying job, or you just received an inheritance. At other times, we have good life reasons to cut our risk exposure, like you are retiring, getting divorced or planning to make a big purchase soon. But, let’s be clear that one of those reasons for strategy changes is not because the markets went up big or down big. Those are past events that are out of your control and we don’t know the future.

3. Changing your investment strategy (approach/method) according to markets

Now I’m going to get into hot water. The financial planning world would fry me for saying this, but I think there is a legitimate time and place to adjust your approach to investing based on observable market conditions. I chose my words very carefully with that sentence so please pay attention. 

When I’m talking about your approach to investing in this context, I am referring to your method and process, or effectively your “strategy” to investing rather than your current portfolio of holdings per se. There are many ways to skin the cat in the investing world but let’s just focus for now on the passive versus the active approaches as different strategies. Is there a time and place to switch between a passive approach (buying and holding a mix of indexes through all market conditions) and a more active approach (dynamically shifting assets according to market conditions, leadership, risks, and opportunities)? My answer is YES! Shots fired! But we can only make such a strategy change based on observable conditions that might justify such a change. 

What are observable market conditions? Glad you asked.

Observable means data-driven, empirical or evidence-based. We cannot allow ourselves to speculate here about what might be. We must only look at what is. One observable condition that might justify a move between passive and active strategies is the current valuation of the stock market. Is the market cheap or expensive by historical standards? This is an observable bit of information with very solid historical precedent and outcomes to help us make this judgment. When the US stock market is cheap, after lengthy periods of price deterioration (aka bear markets) and earnings are beginning to rise, we can empirically observe that downside risk is limited, and upside return potential is wide. During these periods, we would want to adopt a passive buy and hold index approach with some portion of our money, perhaps a lot of our portfolio, as these are the best environments for low-cost indexing. 

Now, the opposite is also true which is what we observe in today’s market conditions.

 Today’s stock market is now either the 2nd or 3rd most overvalued stock market of all time including the years just prior to the last two bear markets and the Great Depression. 

Wise investors will observe this condition and consider more active strategies that allow for selection and risk mitigation to help avoid losses. It is impossible for me to say when the current bull market in stocks will end, but we can observe with perfect clarity that stocks in the aggregate are now wildly overbought and in most cased overvalued for their current state of earnings. 2019 was an explosive year for stock prices but corporate earnings continue to fall month over month, quarter after quarter. Share prices are rising on the back of financial engineering (share buybacks) and multiple expansion (prices just go up without earnings). My bias is going to show through here. Active management strategies have the best chance of putting your money in the right asset classes, stocks, sectors or countries that still offer value while avoiding those segments that are almost insanely priced. When you own an index, you mostly own the overpriced stuff as most indices are driven by stocks with the highest market capitalization (S&P 500) or price (the Dow). Active strategies will lag any passive index approach in a year like 2019 but they will outperform in years when prices fall. So, there is a solid case to be made right here and right now, to consider a strategy shift from a passive strategy to an active strategy. 

We are specialists in active, risk-managed and tax-efficient strategies

               This is what we do, and we have a long 25-year history of success. This is not our first rodeo. I expect exactly no one to call us right now and consider a shift from a passive index approach to an active strategy but this is the time to do it with plenty of observable market evidence to back that claim. We are here to guide our clients within our managed accounts but also to help non-clients work through tough decisions. Should you make a strategy change? Call us to discuss your personal situation.

Following these rules will dictate your success or failure as an investor

               Following the rules, we outlined above takes a lot of discipline, emotional strength and a healthy amount of market experience. Inexperienced investors just make the same mistakes repeatedly yielding big wins and losses, ultimately buying high, selling low and repeating this devasting cycle over and over again. Those who have the discipline to make strategy changes only when it’s appropriate can do quite well, preserve their capital during tough markets, make consistent returns year over year, retire earlier than they thought and enjoy spending time with family, friends, etc. instead of fretting about their portfolios.  

Just a gentle reminder to any and all


Sam Jones