Is the World Still Round?

“Stop going for the easy buck and start producing something with your life. Create, instead of living off the buying and selling of others.”

-Martin Sheen as Carl Fox, Wall Street

For centuries European explorers navigated the globe on what was then the prevalent assumption that world was flat, and that a terrible and unimagined fate befell those who traversed too close to it’s edge. While the scientific knowledge of the Earth’s roundness was said to be known as far back as the ancient Egyptians and through to the Greeks and even the Mayan civilization, you could argue that nobody knew for sure until Magellan’s circumnavigation of the globe, a journey he did not survive, actually proved it. 

This metaphor could certainly be stretched to the modern world of investing, where events of the past year have painfully demonstrated that many of the old assumptions we have relied on to build our models have proven to be incalculably wrong. And while there were wise seers among us who had been ringing the warning bells for some time, too many important people with enormous vested interests chose to ignore the signs that, indeed, the world had changed and this time was different. Hence we find ourselves in a bit of an American existential crisis, trying to tackle larger societal issues at the same time we grapple with our own personal demons of foreclosures, bank runs, taxpayer bailouts, loss of retirement savings and possibly even bankruptcy. To put it mildly, we are all of us in a muddle. But it doesn’t have to stay this way if we, like our forebearerers, realize the shape of the world has changed.

By now most of us who have been paying a least a little attention to the credit crisis ( a term my wife makes fun of because of its overuse in the alarmist media- a crisis is usually short term in nature, this now being more of a new condition) have had their fill of terms like Collateralized Debt Obligations and Credit Default Swaps. The arcane world of high finance has come home to roost on Main Street, which is appropriate because it is actually the value of homes on Main Street that was the catalyst for much of the problem. The blame game has not been fully played out, nor will it be until the next election is clearly in the rear view mirror. Pick one: Greed of (Wall Street, Main Street, Speculators, Developers); Failure of (Bush Administration, Clinton Administration, SEC, Congress, the Fed); Effects of (Globalization, Deregulation, Low Interest Rates). You get the point. Clearly there is plenty of blame to go around- after all we are political beings and taxpayers in an election year. We will most certainly be seeing and have seen the “perp walk” of former investment banking CEO’s paraded in front of Congress to get their 100 lashes much as we did in the bad ol’ days of the “tech-wreck”, Enron, and Worldcom. However, the biggest mistake I think we can make, both as investors and policy makers, as we attempt to learn our lesson from this is to go back to the way things were and pretend that its business as usual.

The nearly overwhelming drumbeat of doom that has been sounded by the media and pundits during the unfolding of our current financial crisis can and does have a significant impact on our ability to stay focused on our retirement and our family’s own financial future. We are driven by fear which gives way to Panic. We make decisions in highly emotional states. On more than one occasion have I talked to an investor who has reached his or her own “pain threshold” as the market grinds inexorably downward. It is understandable. It is often the case that yes, this particular investor did not get her “risk tolerance” profile right when she started investing. But who thought it would look this? This is much more than a percentage decline figure on a questionnaire. This is our life savings. This is our retirement. This is real, and it’s painful. And then the second guessing begins: “I should have rolled that money into a CD”, or “The interest rate on that savings account wasn’t that bad.” Should have , would have , could have…But I’m here to tell you that none of that matters right now, just as telling yourself you should have taken a different path after stepping off into quicksand doesn’t help you get out.

The 21st Century has just crashed the creaky, rusted economic and financial framework of the 20th. I am going to state now what I said to my clients after the bear market of 2000-2002, that is, we need to re-adjust and right-size our expectations both for our retirement as well as our expected returns in the equity markets. They go hand in hand. Someone who had started their investment journey in 1998 expecting the domestic stock market’s long term average of 10% annualized rate of return is sorely disappointed. They would pretty much be back where they started, all things being equal. So for many it’s not just a function of losing money, it’s also losing valuable time. What we are seeing now is an unraveling of years worth of bogus earnings in the stock market, propped up by leverage (debt) at all levels of our economy, including us, the investor/consumer coupled with a sanguine attitude for risk. We are now the biggest debtor nation on Earth with the most indebted citizens.. The American consumer has been the engine of global economic expansion for the better part of a century and we are tapped out, exhausted. As a country, as an economy, we simply cannot continue going doing the things we’ve been doing and that includes the way we invest our money. Or, as I heard one homespun observer put it, “keep on doin’ what yer doin’, you’re gonna get what ya got.” It is time for us to wake up and smell the New World Economic order, for in it there will be opportunity but also risk. It will probably also mean the need for greater savings rates because the market won’t be bailing us out, which means constraints on our lifestyle. It may mean delaying gratification, possibly including retirement. It may mean changing long held assumptions about the allocation of our investments. Without meaning to sound alarmist, listening to experts who counsel “stay the course’ may just lead your ship right onto the rocks. Staying the course if you were in the NASDAQ in 2000 meant riding your holdings down from its high of 5200 to its present level around 1750. Is anyone going to seriously going to argue that this once-influential index is going to make up that ground anytime soon? Are the once hallowed institutions of Wall Street like Bear Stearns and Lehman Bros. coming back? No. the course has clearly changed, and the ride to its eventual destination will most likely not be a smooth one. Above all, it will be imperative to work with advisors and money managers whom you not only trust but who also have the vision and the courage, like Magellan, to navigate the new shape of the world and be able to decipher what is the new reality and what is just so much noise.

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