Investing in the wrong place at the wrong time … again?

When people find out I’m in the investment business, they usually ask me where to invest. They ask if it’s better to be in stocks, bonds or real estate. They want hot tips like, are U.S. stocks better than international stocks? What about China and Brazil? Etcetera, etcetera.

Next, they tell me their horrible investment experiences. Typically, they’re convinced that anything they invest is destined for doom. This leads me to ask, “Why do the majority of investors have bad experiences?”
It doesn’t help that for the past 10 years, the stock and real estate markets haven’t gone anywhere. After mostly going up during the ’80s and ’90s, the markets went down hard between 2000 and 2002. From 2003 through 2007, they did great. But what came in 2008 to early 2009 was one of the worst bear markets in history, after which the markets rallied once again.

It’s understandable investors have had it tough. However, studies have shown that the average investor did poorly during the good times, too. Historically, retail investors have underperformed when markets are good and performed horribly when markets are bad. No wonder investors are frustrated and disillusioned.

So, are people hard wired to invest in the wrong place at the wrong time? Yes. And I’ll tell you why: emotions. Most investors invest based on emotions, driven by a constant tug-of-war between fear and greed.
Will Rogers said investing is simple: All you do is buy low and sell high. The problem is when prices are low, everyone is consumed with FEAR. And that is precisely when they should invest.

The other side of the cycle is when markets have gone up. Investors tell their friends about the 20 percent return they got last year, and all of a sudden the 1.5 percent they got in their CD doesn’t look so great. So then they, along with millions of other investors, come piling into the market consumed with GREED.
This cycle of fear and greed repeats itself over and over. Consider where the masses invested the past 10 years. Back in 2000, record numbers flooded the stock market right before a horrible three-year bear market hit. Investors in the NASDAQ watched their accounts lose 80 percent of their value.

Many of those investors said they would never invest in stocks again. So they piled into real estate to be safe. As we saw in 2008, it wasn’t safe after all. Depending on which part of the country they were in, they experienced losses anywhere between 30 and 80 percent. Some leveraged real estate investors lost everything.
For the past year, we’ve seen investors piling into bonds. Bonds have been pushed to the lowest yields I’ve seen — simply because everyone is buying them “to be safe.” The bond bubble looks a lot like the previous stock and real estate bubbles. Odds are that investors who buy bonds for safety are about to get crushed.
At Paragon Wealth Management, we avoid emotional investing by following our quantitative models. We do not care what the media is saying or what we hope or how we feel. Our models process the market data and we invest accordingly. We are constantly adjust our portfolios to what the market is actually doing.

Paragon cannot guarantee the accuracy of information from other sources. Opinions are as of the dates indicated only. This report is not a solicitation for any security. Past performance is not a guarantee of future results. Investment performance reflects time and size-weighted geometric composite returns of actual client accounts. Investment returns are net of all fees and costs. The S&P Index is a diversified, size weighted index of 500 stocks.

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They’re upset … but they don’t do anything about it. They seem to believe the situation will somehow fix itself. What they don’t realize is if you do what you’ve always done, you’ll get what you’ve always got. Insanity is repeating the same poor actions over and over — and expecting a different outcome.

There is a much better way to invest, but it requires you to take action and be proactive. It all starts with selecting a quality financial adviser. Interview a prospective financial adviser just like you would a prospective employee. While hiring the wrong employee can cause unnecessary grief, hiring the wrong financial adviser can wreak havoc with your entire future.

Often, because people don’t know how to evaluate an adviser, they simply invest with the first person that impresses them. This is a mistake. The best salespeople are not necessarily the best advisers.
We provide educational resources on our Web site, www.paragonwealth.com, that outline seven steps to selecting a financial adviser. Three of them are non-negotiable. First, the adviser must be a fiduciary. Second, he or she should have 10 years of investment experience. And third, the adviser needs to show you a 10-year investment track record.

These may seem like stiff requirements, but they will significantly increase your odds of success.

Why is it important to find a fiduciary adviser? Fiduciary advisers have a legal obligation to put your interests ahead of their own. They are held to a much higher standard. Most people do not realize that all financial advisers are not fiduciaries. Surprisingly, it’s been estimated that only about 15 percent of advisers are fiduciaries. Generally speaking, most sales reps who receive a commission for selling financial products such as annuities, insurance and mutual funds are not fiduciaries. On the other hand, Registered Investment Advisers and their reps usually are fiduciaries.

Why should they have 10 years of experience? Because markets are difficult to navigate and are constantly changing. Ideally, your adviser should have experience investing in both good and bad markets. Experience is critical.

Why should you require them to show you their 10-year track record? If they don’t, then how do you know what they’ve done for prior clients? Talk is cheap. Legitimate advisers can show what they’ve done for clients over the years. Showing you the track record of a mutual fund, a hypothetical model, or anything else they have recently started selling does not count. They need to show you their own track record, which would be a composite of the results of their previous clients’ investments. Any adviser who refuses to show you their track record should be crossed off your list.

Make sure your adviser meets these three requirements. If you are not happy with your investment performance or your current adviser, do something about it. Poor investments will not fix themselves. To improve your situation, you must be proactive.

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This stress-free picture describes what an ideal investment program would be like — a low-stress, methodical strategy that allows you to reach your long-term goals.

Is it possible to have this type of experience?

Over the past 10 years, many investors’ experiences have been more like riding a roller coaster in the dark with no brakes, which is the complete opposite of low stress.

While it is impossible to have a completely stress-free experience, it is possible to reduce stress significantly by building a portfolio that is aligned with your specific risk tolerance. Your risk tolerance determines how aggressive or conservative you are invested. Your particular mix might be 20 percent conservative and 80 percent growth, 50/50, 70/30 or some other combination. It is different for each person. It depends on your individual goals and objectives and what you can handle.

Every investor has an amount of risk he or she is comfortable with. If your risk level is set too high, you will most likely have a hard time every time your account value declines. If your risk level is set too low, your returns may be inadequate, and you will never reach your goals. Basically, when it is not set right, you will worry every time the market drops and become euphoric every time it goes up.

Why is this so important? Because many investors do not consider how much risk they are signing up for when they initially invest. It might be invested in a way that you will lose everything when something goes wrong. For long-term success, it is critical you have a clear idea of exactly how much risk you are exposed to. Otherwise, your chances of success are slim.

Paragon cannot guarantee the accuracy of information from other sources. Opinions are as of the dates indicated only. This report is not a solicitation for any security. Past performance is not a guarantee of future results. Investment performance reflects time and size-weighted geometric composite returns of actual client accounts. Investment returns are net of all fees and costs. The S&P Index is a diversified, size weighted index of 500 stocks.

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In an effort to stem the overwhelming tide of fear, we created a presentation called “Is The World Ending?” In short, we didn’t believe it was the end. We believed the entire situation had evolved into unwarranted panic and fear, and we advised clients to become fully invested.

As we expected, the March lows were the market bottom. Since then, the economy has moved back from the precipice. In mid-July, we wrote several articles stating we believed the recession actually ended around June 30. Since the March lows, the U.S. market has gained 50 percent, retracing a good portion of the losses since last fall. Many of the international markets have come back even stronger, with the emerging markets leading the way.

Buy and Hold?
So, after all of this market drama, what is the best way to invest? Wall Street, mutual funds, stock brokers and financial planners all pitch “buy and hold” as the best way. Buy and hold is the most “promoted” investment strategy there is. John Bogle, founder of Vanguard Funds, is the poster child of the buy-and-hold strategy. He endorses it with evangelical zeal. Buy and hold is an investment strategy where you simply buy an investment and then hold it indefinitely. In theory, as the markets move up and down, your investment moves up and down, but over time you are rewarded.

Active management is a strategy where you are constantly adjusting your portfolio to what the market is doing. Unlike day trading, most active strategies are trying to capture intermediate term (three to 18 months) moves.

There has always been a debate whether buy and hold or active management is better. Since this is such an emotional debate, let’s look at the numbers.

In mid-October, the Dow Industrials moved above 10,000. Everyone cheered. The last time it hit 10,000 was about a year ago, on its way down. Looking longer term, the Dow Industrials first hit 10,000 back on March 18, 1999. That was more than 10 years ago. During that 10-year period of time, faithful buy-and-hold investor’s returns have been almost non-existent. When you factor in inflation, the returns are actually negative.

The Dow paints a relatively positive picture. Let’s say you invested in the NASDAQ (which represents 6,000 stocks) more than nine years ago on March 10, 2000. Buying and holding the NASDAQ from March 10, 2000 through Oct. 16, 2009 would have given you a loss of 57 percent. Out of curiosity, just how much longer do the buy and holders recommend you keep holding the NASDAQ?

Active Management
At Paragon, we are proponents of active management. And the numbers back us up. Both of our actively managed portfolios are doing extremely well year-to-date. Stocks trounced bonds, small cap and mid cap stocks outperformed large caps, and emerging markets outperformed all asset classes. Fortunately, that is where our models positioned us, and it is why our portfolios once again outperformed their benchmarks. Our conservative portfolio, Managed Income, is up 11.93 percent year-to-date, through Sept. 30 — more than doubling the 5.72 percent for its benchmark, the Barclays Bond Index.

Our growth portfolio, Top Flight, is up 27.7 percent year-to-date, through Sept. 30 — versus 19.3 percent for its benchmark, the S&P 500. Since January 2007, Top Flight is down only one percent versus its benchmark, the S&P 500, which is down 21 percent during the same period. Since its inception in January 1998, Top Flight has gained 337 percent versus only 33 percent for the S&P 500 index.

Active management does work.

Paragon cannot guarantee the accuracy of information from other sources. Opinions are as of the dates indicated only. This report is not a solicitation for any security. Past performance is not a guarantee of future results. Investment performance reflects time and size-weighted geometric composite returns of actual client accounts. Investment returns are net of all fees and costs. The S&P Index is a diversified, size weighted index of 500 stocks.

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Since the March 9 low through July 31, the S&P 500 has gained 46 percent. It has made back its losses from January through mid-March and is now up 10.9 percent year-to-date through July 31.

During that same time, our growth portfolio, Top Flight, is up 17.2 percent year-to-date. The reason we are up substantially more than the market is because we invested in those areas that perform best after a severe market decline — just like we recommended.

If you followed our advice, you were rewarded. But going forward, the question is how should an investor be invested? In July, our indicators and the models we follow indicate there is a high probability the recession ended in June — although this hasn’t shown up in the press and is not yet mainstream knowledge.

The first and sharpest stage of market recovery usually occurs right after the initial market plunge and takes about three to four months. We believe stage one occurred between March 9 and June 30. The second stage of recovery occurs after the recession ends, which we believe was around the end of June.

If it is true the recession ended in June, then we now want to be invested in those areas of the market that do best during the second stage, or after a recession ends. The second stage lasts for about six months. Following the last 11 recessions, the data clearly shows that certain areas of the market consistently perform best during stage two.

Typically, bonds perform poorly after recessions and should be avoided. Interest rates get pushed down during the recession, and then, as the economy starts to expand, demand for money increases and interest rates go back up. When interest rates go up, most bonds get hammered and lose money. Bonds are one of the worst places to be as an economy emerges from a recession. Unfortunately, many misguided investors have been running to bonds for the past six months, hoping to find safety. If history repeats, they will find the opposite of what they seek.

From a big picture perspective, small cap, growth, commodities and emerging market stocks have performed the best for the six months following the end of the recession. On a sector basis, energy, materials, tech and consumer discretionary stocks performed the best.

On the other hand, in addition to bonds, other sectors that usually perform poorly after a recession ends — and should be avoided — include consumer staples, health care and telecommunication stocks.

This difficult market highlights why “active” investment management is so important. If market dynamics always stayed the same, then a simple buy-and-hold approach would most likely work well for investors. Because market dynamics are constantly changing and evolving, we believe the best investment approach is one that actively adjusts, moves and changes based on market conditions.

The views in this column are my opinions. They are not intended as a forecast or a guarantee of future results.

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Earlier this year, I predicted that once we got to a point that President Obama could speak on television — and the market would go sideways or up — it would be a sign the market may have hit the bottom. Once you hit a certain point, you run out of sellers, and there is nothing left to bring the market down any further.

After watching a politically perpetuated 25 percent drop in the Dow Industrials this year alone, it appears we may have hit the market low on March 9.

The market was so low at that point — down 54 percent from its peak — it appeared as though everything negative had been factored in, maybe several times over. At that point, confidence was completely destroyed, such that high-yield bond default rates were projected at double what they were during the Great Depression. Another metric showed consumer spending at the same level it would be if unemployment were 30 percent. (It’s actually 8.5 percent.)

Imagine you were asleep the past 18 months and just woke up. Looking forward, not backward, things actually look pretty promising.

• Six of our eight “bull watch” indicators support the case for a new bull market.
• Most of the economic indicators we watch have stopped declining and are now moving sideways or up
• Housing is more affordable and mortgage rates are lower than they have been for some time.
• Energy is more affordable for consumers and businesses.
• Credit has loosened and interest rates are extremely low.
• Massive global government stimulus is occurring.
• An abundance of investor cash is on the sidelines.
• This has been called the sale of the century. In inflation adjusted terms, the March 9 low point put the Dow Industrials at the same level they were 43 years ago. In 1966 there were no PCs, no Internet and our workforce was half the size of what it is today.
• Four-fifths of top economists in the latest Wall Street Journal survey said now is a good time to buy stocks.
• Investor sentiment has reached the negative extremes and started to reverse.

Going Forward
Both our conservative and growth portfolios were down during the first quarter. By the end of April both portfolios had reversed strongly and turned positive for the year. Both portfolios continue to be invested in areas of the market that have historically performed the best after a bear market. After the 2000-2002 bear market, we were able to almost double the return of the market averages by positioning our portfolios in the best places.

This is the 34th bear market in the past 100 years. The future always looks bleak when the bear market is the worst. People become irrationally pessimistic. That is when the naysayers have their day of fame. They get all the press and the media loves them. They always expect things to get worse and they always attract a lot of followers. And they have always been wrong. Not wrong once or twice, but the past 34 times.

Our economic system is resilient. Our markets and our economy have always recovered from these difficult times in the past. We’ve made it through recessions, world wars, a civil war and a depression. I believe in the free market system. Our market and economy will recover again. I believe we are living through an investment opportunity that only happens once or twice in a lifetime.

Don’t let it pass you by …

The views in this column are my opinions. They are not intended as a forecast or a guarantee of future results.

For many, a down economy typically translates into a downer mentality. The volatile market can be overwhelmingly discouraging, which leads business leaders to sit in their office with their head in their hands, saying, “Tell me when it’s over.”

The good news is it doesn’t have to be this way. A less-than-ideal economy can lend itself to a better-than-ever situation. All you have to do is plan for it.

The situation
There’s no denying the economy is in trouble or that people are seriously struggling. The market has been obliterated over the past few months, coming in at levels it was 11 years ago. The world has been turned upside down.

The market, essentially, has gone through nature’s equivalent of the “100 year flood.” Meaning, that this downturn was inevitable — it had to happen. And because of that, it’s more important than ever to be alert, active and aggressive. That deer-in-the-headlights mentality isn’t going to do you any favors.

Stocks have gone down, and they’ll go back up. We just don’t know exactly when. So it’s essential to evaluate your options and look to the future.

The emotion
The market is often described as psychology in motion. It’s all based on confidence. For example, going into the election, consumer confidence was down. The politicians were telling people how bad things were, and they were scaring everyone to death.

Then we elected the new president, and consumer confidence went up 11 points — that day. President Obama hadn’t done anything yet, but the perception of what he might do positively impacted the consumer confidence numbers.

The bottom line, is when confidence leaves the system, everything comes to a standstill. People stop spending because they’re scared — despite the fact that they still have a job and their paycheck hasn’t changed.

The right move, however, is to do the opposite. Normally, we have to scour for the kind of deals you can find in today’s market. But now the situation is akin to someone pulling up with a dump truck full of bargains and leaving it there for the taking.

The planning

Taking advantage of the incredible bargains requires strategy and forethought. You can leave it to random luck, or you can strategically position yourself for great returns. People will go to an accountant for bookkeeping, an attorney for legal issues and a doctor for health. But when it comes to financial matters, they think they can do it on their own. You can sometimes get away with that in an easy market, but at a time like this, it’s essential to hire a professional.

Here at Paragon Wealth Management, we offer a free portfolio review and analysis for investors with $200,000 or more in their account. It’s a way to make lemonade out of lemons. Now is the time to position yourself in a way that allows you to capitalize on an opportunity that rarely comes along.

The views in this column are my opinions. They are not intended as a forecast or a guarantee of future results.

After graduating from BYU, Dave Young started his career as an entrepreneur. He successfully started 12 businesses in the early 1980s. In 1986, he decided to sell his businesses and invest the proceeds, but he was unable to find an investment company that met his needs. As a result, later that year he began managing his own portfolios. Young continued researching methods for investing that would produce the most profitable returns. He believed in his methods so much that he invested his life savings and started Paragon. More than 20 years later, Young continues to invest and research ways he can improve his business to serve clients. He has been interviewed by BusinessWeek, CNBC, the Wall Street Journal, the Deseret Mornings News and other national and local media. Paragon also received the Best of State Award in Financial Services for 2008. Visit www.paragonwealth.com or call (801) 375-2500 to learn more.

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The stock market just endured the worst October since the crash of 1987. It was slammed by what Alan Greenspan called a “once in a century credit tsunami.” He said it shattered some of the models he has relied on over the past 40 years.

Volatility hit levels I’ve never seen in my 25 years of investing. The selling was massive and it affected every asset class. Whether you invested conservatively or aggressively, everyone felt the pain. In previous declines, about 30 percent of stocks move up while the majority moves down. This time, there was nowhere to hide with 98 percent of stocks moving down. Since last October, the S&P 500 has lost about 45 percent of its value.

What do we do next?
In previous panics, it’s been a mistake to follow emotions and sell after a crash. It’s better to take a deep breath and assess how much downside risk there is versus upside potential.

This is the 34th bear market since 1900. During that period, it is the 5th worst decline in U.S. market history. Stock prices are down to the levels they were 11 years ago. That means stock prices don’t currently account for growth in population, advances in technology and gains in productivity of the past 11 years. Every statistical measure we use to value stocks indicates they are screaming bargains.

The average return after previous bear market declines has been 296 percent. As the market recovers, these returns usually come in bursts, which is why it is usually a mistake to sell out in the depth of a bear market.

Reasons to be hopeful
The market hit extreme lows on Oct. 10. Since that time it’s moved violently up and down but has stayed above the Oct. 10 lows. Each time the market has sold off since then it has been on low volume, which is a good sign. Also, 11 of our 12 bottom-watch signals signify we’re close to a bottom.

This sell off started as energy prices moved higher. Every time oil prices went up the stock market went down. Higher gas prices gave consumers less to spend, which was negative for the economy. The price of oil has since quietly dropped from $147 to $60. Hundreds of billions of dollars sent overseas for oil are now staying here. This savings should act as a stimulus and be positive for our economy.
The subprime lending mess also contributed to the market meltdown. It evolved into a credit crisis, which almost brought our economy to a halt. Our government throwing $700 billion worth of stimulus into the banking system will likely repair the credit mess. It will take time, but it should fix another problem that brought the market down.

The longest presidential election ever
We just endured the longest election of all time. Twenty months ago, Barack Obama began telling us how terrible things were and how important it was we elect him to change them. When he started his campaign, things were actually good and we were in the late stages of a five-year economic expansion. Even though our economy was hitting on all cylinders, he did his best to convince us otherwise. His negative spin negatively affected consumer and business confidence.

Our economy is based on confidence. If you kill that confidence, you kill the economy. Consumer confidence levels are now at an all-time low. Obama proved if you say something long enough, people will start to believe it. The good news is the election is over and his drumbeat of doom should now turn positive.

I can’t see into the future, but based on history, it appears we are bumping along a market bottom. My general recommendation is to stay invested and move your portfolio into areas of the market that historically come back the fastest when recovery begins. Keeping a long-term focus has always rewarded investors in the past.

ABOUT THE AUTHOR
After graduating from BYU, DAVE YOUNG started his career as an entrepreneur. He successfully started 12 businesses in the early 1980s. In 1986, he decided to sell his businesses and invest the proceeds, but he was unable to find an investment company that met his needs. As a result, later that year he began managing his own portfolios. Young continued researching methods for investing that would produce the most profitable returns. He believed in his methods so much that he invested his life savings and started Paragon. Over 20 years later, Young continues to invest and research ways he can improve his business to serve his clients. He has been interviewed by BusinessWeek, CNBC, the Wall Street Journal, the Deseret Morning News and other national and local media. Paragon also received the Best of State Award in Financial Services for 2008. Visit www.paragonwealth.com or call (801) 375-2500 to learn more.

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