Tuesday, May 5, 2009

Cinco de Mayo: A Victory for the Underdog

One of the many hats I wear is that of an investor. For decades, I have invested in the stock market, beginning after college when I had saved a few thousand dollars. I enjoy the number-crunching of investment analysis, finding undiscovered small companies, and putting my money where my mouth is. It is always a challenge, and I have made mistakes, but I have also returned to my mistakes to learn from them. Serious investing is investigative and practical. It is also a recursive process in which you are constantly evaluating your premises for a particular investment, as well as your evolving skills and sensibilities as an investor.

One of the things I learned about myself, during this vicious bear market, is that I need to increase my allocation for bonds in my overall portfolio. There is nothing like a heart-thumping drop in the stock market, month after month, to force you to reevaluate your strategy. I did not sell any individual stocks or mutual funds, so I did not panic and I have benefited from this bounce back from recent lows.

But in March I did feel financially vulnerable, since in four short years my older son Aaron will attend college. Now that the S&P 500 is above 900 at least for a day, I won’t go back to my 80/20 split for stocks and bonds, but instead will keep adding new money primarily into my bond portfolio. I am focusing on short-term bonds, because I believe interest rates are at historic lows, and can only go higher. Short-term bonds will be hurt the least when this happens. Remember, bond prices go down when interest rates go up, and vice versa, and this relationship is more pronounced the longer the maturity of the bond.

I am a contrarian, and this belief in my head was indeed proven by what I did with my hands and feet. I did not panic as the Obama administration got a handle on the financial mess it inherited, and as credit markets froze and threatened to turn a deep recession into a depression. I did not panic as a few mega-banks teetered near insolvency, as deficits soared because of federal bailouts, as swine-flu hysteria gripped the nation. It is important to assess how you reacted in critical situations to get a sense of who you are. You don’t know what kind of soldier you are until the bullets whistle past your ears.

We are not out of the woods yet. Corporate earnings may turn more negative than they have been so far, or we may experience flat to weak economic growth for many years, or some unforeseen event, like a run on the dollar, may undermine financial stability. The second and third waves of past flu epidemics have often been deadlier than the initial wave. So I am still wary, but I have taken steps to take advantage of overreactions and to be better prepared for the next crisis.

I am a relentless cost-cutter, and this attitude has helped me to evaluate what we spend money on and whether it is worth it. This cost-cutting also helps me to be better prepared for crises: companies and individuals who are careful with their money and carry little debt are better able to weather downturns. That’s a truism we should live by as investors and as responsible parents.

Sometimes my writer friends, who are terrible at managing their own financial affairs, ask me why I worry so much about money. Invariably this happens a few days after they’ve asked for a loan. I tell them what I’ve always told them. Investing is not about getting rich, or having more toys, or impressing others. It’s about independence. It’s about doing what you want, when you want, and not having to ask an ornery friend or a boss for more money, and not getting it.

Cinco de Mayo celebrates the underdog Mexico defeating powerful France at Puebla in 1862. The individual investor is the underdog in today’s investment world. Do your homework, know thyself, and think independently, and perhaps you will also reap an unlikely victory. Happy Cinco de Mayo.