I thought I would take the opportunity this month to share a quarterly letter written by Matt McGrath, who is the managing partner in our office. Although Matt writes one of these each quarter, I was impressed with this one, because he answers the kinds of questions that we are currently getting from clients every day. Enjoy.

 

Dear Client:

In case you missed the news, on September 20, as the third quarter of 2010 was rolling to a close, the National Bureau of Economic Research announced that the Great Recession ended over a year ago in June 2009. However, this seemingly great news was largely ignored by the general public. Why the indifference?

Actually, it is perfectly understandable when the rest of the story reveals unemployment rates still hovering near 10%, foreclosures overwhelming an already strained housing market and stock markets still well below their pre-recession peaks. The dichotomy of good and bad economic news continues to reign as the theme of the day. So the real question is, "What should you do about it?"

Allow me to digress for a moment, if you will. I was recently playing basketball with my son in our backyard. At one point the ball went under his foot as he was running, and he ended up on his shoulder, sliding across the brick pavers. Needless to say he was suddenly in a lot of pain.

There was actually about a one-second delay as he processed what had just happened. How badly am I hurt? What is going to happen to me? What should I do next? After determining there was no major damage, we went inside the house and put some ice on his shoulder. He proceeded to take pride in showing off his battle scar to my wife and her parents and then took extra care to protect his shoulder for the rest of the day.

The next day he was still pretty sore, but started to feel a little better. By the third day he was recovering and already back out on the basketball court with his friend. As I write this letter, he still has a silver-dollar-size scab on his shoulder that continues to heal as he goes about his daily activities, the initial injury largely forgotten.

Maybe you already see where I am going with this, but as we look back on the last couple of years, I would argue that many investors have been through the emotional equivalent of what my son experienced after falling on his shoulder. A sudden unexpected shock to the economic and financial markets caused an immediate sense of fear. How badly am I hurt now? What is going to happen to me? What should I do next?

As the initial shock faded, the next step was to assess the extent of the damage. Make sure adequate cash reserves were in place, make sure the asset allocation was still appropriate and make sure the financial plan was still on track. Finally recovery took hold in a slow and steady manner. In fact, recovery is still taking place.

Despite the ongoing recovery, pessimism is still at fairly lofty levels when it comes to the economic and financial state of the world. Corporate America continues to "self-insure" by stockpiling cash. Investor dollars continue to exit equity mutual funds despite the phenomenal resurgence that has taken place over the last 18 months or so. Healthcare reform, financial reform and a pivotal election leave our heads practically spinning with uncertainty as to what to expect in the coming months and years. This brings us back to the question, "What should you do about it?"

As much as it pains me, I know my son is bound to get hurt again. He also knows there is a very good chance he will experience another painful injury at some time in the future while playing basketball. But will that prevent him from playing? No.

Likewise, we know that the financial markets will give us more pain at some point in the future. You might ask, "Why don't I just sit out until I'm fully healed?"

But it is important to remember that we cannot predict when the next painful market experience is going to take place any more than my son can predict when he will get hurt again playing basketball. If you try to sit out of the market until it "heals," you will inevitably end up sitting out until it is even higher than when you originally left.

Even worse would be the periodic "fat tail" we get from the markets, where returns skyrocket in a very short period of time. Remember, many years' worth of returns can take place in just a matter of months, and there is no way to make them up if you are on the sidelines when they occur. The bottom line is if you need or want the long-term returns possible with stocks, you simply cannot afford to sit out.

Of course, we can still choose to learn from our past experiences. My son can play basketball a little more carefully, and you can adjust your financial plan to account for the uncertainty. The key to making that happen is having a plan in place and being comfortable with that plan.

Your investment policy is an integral part of that plan and serves as the road map to help navigate the uncertainties in front of you. There are no 100% guarantees in the investment world. As we enter the fourth quarter of 2010, we can probably expect the uncertainty of economic news to continue.

Corporate earnings, the job market and housing will continue to jockey for attention. If your big-picture plan is on track, though, you should not allow these short-term uncertainties to affect your day-to-day life.

That being said, there are some things you can do in order to prepare for the uncertain future. You can start by revisiting your financial goals. Are there any big changes that may require adjustments to your plan? If so, discuss these issues with us.

A plan is only as good as the assumptions used to populate it. Changing jobs, retiring, moving, new kids and grandkids are all examples of the types of things that may require modifications to your plan to keep you on the right track.

Continue to maintain adequate cash reserves. You may be reluctant to keep one or two years of cash needs set aside at a time when short-term interest rates are approaching zero. However, when looking back over the last couple of years, it quickly becomes evident how important it is to do so.

Everyone wants to buy low and sell high. Avoiding the necessity of selling stocks at a bad time means not having to sell low. Maintaining ample cash reserves also helps do something we strive to achieve for all our clients-it helps you sleep well at night during turbulent times.

In the meantime, we will continue to look for ways to fine-tune the risk/return relationship of your portfolio. Our crystal ball is as cloudy as anyone else's today, and while we may have our own opinions on the future, we will never claim to know what exactly is going to happen.

Recently most of our clients had their portfolios rebalanced to reflect modifications to the investment policy as suggested by our investment committee. The details were spelled out in previous communications and were the result of many months of thought and discussion within our investment committee. Most of the changes will be reflected in the third-quarter reports contained in this packag of information.

The Great Recession may have ended a long time ago, but we will always face an uncertain future. We will continue to deal with the uncertainty in the world in the best way we know-by following a plan.

If you have any questions or concerns about your own plan, please do not hesitate to contact us so that we can help you feel as comfortable as possible.

 

Cordially yours,

Matt McGrath, CFP

Managing Partner

 

Deena Katz, CFP, is an associate professor in the personal financial planning division at Texas Tech University. She is chair of Evensky & Katz in Coral Gables, Fla.