Saturday, May 05, 2007

What's Your Ben & Jerry's Investing Moment?

The market has been setting a new record everyday now it seems. The Dow Jones Industrial Average closed on Friday at 13,264.62, a new all time high. And the broader Standard & Poor 500 Index also closed at 1505.62, also a new all time high.

I had a conversation with a friend the other day who is an active investor, and I mentioned that I'm 20% cash. He was surprised.

"You don't need to be 20% in cash!", he explained. "You're not going to need that money for 30 years. You should be more aggressive!"

And he's totally right.

Sort of.

I could certainly stand to me more fully invested. After all, we're talking about a long term investing horizon. And as one who drank the Kool-Aid long ago on the long term safety of equities, I should be able to do so with confidence.

But here's the problem.

One's investing strategy does not exist in a vacuum. It is dependent upon one's Investing Personality. Modern Portfolio Theory does a great job of determining what asset allocation strategy will maximize your returns. But if that investing strategy is not consistent with one's risk preferences, emotional resilience - even attention span, it will succeed in theory, but fail in practice.

Think of it this way: Investing plans are a lot like eating plans. If you want to lose weight, there are any number of diets that will do the job. Barnes and Noble bookshelves are full of them. But what makes a diet right for you, is not whether it "would work" (heck, they pretty much all work). What makes the diet right for you is that it is the plan that you can stick to.

And like proper eating, we're not talking about a short-term, "look good for a wedding" type of situation with our investments. We're talking about following a lifetime plan of prudence and self-discipline. So any long term investment plan doesn't have a built in mechanism for those Ben & Jerry's moments is ultimately doomed to fail. That's why the right plan for me is a sub-optimal investing strategy.

They say that truth lies in paradox. Well here's one for you; I can't be aggressive without a more conservative asset allocation.

When I explained that (emotionally) I needed a decent chunk in cash, my friend assumed it was because I needed to know that at least a part of my portfolio was "risk free". Actually, that doesn't quite hit it.

It's not that the money is "risk free" (i.e., I can't lose it). In fact, the cash position for me gets mentally classified as a loss; I feel like I'm losing money by not having it participate in the rally. No. The reason I need that money in cash is entirely different.

I don't mind risk. In fact, I like being aggressive. But in order to be aggressive (e.g., take some more speculative positions), I need a sense of control. I need to know that if the market gets whacked, I have cash ready to take advantage of it. That way I can cognitively reframe a "bad day" (lost money) into a "good day" (got some bargains). If I couldn't do that, the bad days would overwhelm my portfolio and knock me off course.

For me, losing money only becomes emotionally intolerable when I'm unable to take action, when I can't reclaim some sense of control.

That's my wings/pizza/cheesecake moment. That's when I screw up my plan.

What's your weakness? What are the temptations that push you off your plan? We invite you to check out some of's investor self-assessment tools to determine where you (or your client's) potential vulnerabilities may lie.

In the meantime, eat healthy and enjoy the bull market.

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