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What is Your Season of Investing?

Investing has four distinct seasons: trading, long-term growth, holding, and divesting.  Unfortunately for the investor, these seasons do not necessarily come in order and an investor might be in several seasons all at the same time. To complicate the situation even more, different buckets of money may be in different seasons simultaneously. And finally, your personality and investment choices will dictate which season you are in, unless you are very disciplined about your financial management. Learning the investment seasons is a little more complicated that the seasons of the year, but just as important.

Trading, long-term growth, holding, and divesting—spring, summer, winter, and fall. The metaphor is not exact, but surprisingly close. Failing to learn the signs may leave you caught unprepared in a summer financial drought when children head off to college; or you may get surprised by a winter blizzard when cash runs low in retirement. Learning the signs of each investing season can reward you with prosperity and security.

Trading—the springtime of optimism

In the spring green buds blossom, hope springs up, and (in the folly of youth) we believe we can beat the market. Timing, day trading, puts, calls, commodities, short selling, collars, forex, options, stop-losses, and “can’t lose” market programs all beckon to the youthful investor with the temptations of quick, easy profits.  It’s spring in the financial world and everything looks green. This is trading. A few people make a good living by trading and a few more manage to break even doing trades, but most people lose money on their trades. Even if the trades break even, fees will usually tip the balance into the red.

Successful trading requires intensive study, iron discipline, and constant attention to get the timing right. Most people have a career and a family, so the daily, even hourly, attention required for successful trading is simply not available. Also, most people do not have the discipline to execute a trading program strictly, which is required for long-term success at trading. If you doubt us (and you should), just compare your annual results with a good mutual fund. Statistically, most of us don’t beat the performance of a good mutual fund, and most mutual funds don’t beat the market averages. By any statistical measure, trading is the spring season of investing, when hope triumphs over history.

Long-term Growth—the Summer Growing Season

In the summer, nature gets down to the business of growth. Plants and animals must build enough resources to last the coming fall and winter. Long-term growth is not fast-paced, or even particularly glamorous. It is all about finding green fields and harvesting those green fields as long as possible.
For an investor, long-term growth is staying ahead of taxes and inflation. The single most important concept for long-term investing is the power of compound growth. Investors choose a few successful strategies that utilize the power of compounding and tax deferral to grow faster than inflation and taxes. Any investment that beats inflation and taxes, even if by only a fraction of a point, will create substantial wealth over time. The second most important concept is over time. Compounding works over time. It needs an entire season to grow a healthy asset. Successful investors understand the power of compounding and give their investments time to utilize that power.

Holding—autumn is time for harvesting profits and protecting assets

In the autumn, nature focuses on getting ready for winter. Autumn is for finding caves and burrows to protect the resources harvested during the summer. Autumn is certainly not for taking risks to recoup resources lost during spring frolics of trading, or even missed opportunities in the summer of long-term growth.  The two concepts for autumn are harvesting and protecting your assets. Whatever resources you have grown in the summer of long-term growth, now is the time to reap the profits and protect your assets.

The holding season typically begins about two years before you need the funds. During the holding season you harvest the profits by rotating your funds out of stocks and bonds. You protect your new assets from market risk by holding cash to pay the upcoming expense. The holding season gives you time to unwind investments profitably and to protect your cash from large market corrections. Market returns average 3-7% annually, while market corrections average 10%-40% in a short period. As a result, within a narrow, two year time horizon, your risk of loss becomes larger than your opportunity for gain.

The risk of a large, unexpected drop may be low, but it is real. The stock market roller coaster ride of 2008-2009 certainly demonstrates that. Even after the market’s spectacular rise since March, 2009 (from 6,000 back over 10,000 for the Dow Jones Average) investors who stayed fully invested through the drop and the climb have seen their assets drop about 30%. Prior to that, the stock market saw another large drop in 2001—the dot com bust—only seven years earlier.

These sharp corrections occur often enough that you must use the holding season to protect funds you will need within two years. For example, funds for a child’s college education should be moved into cash starting two years before that first college tuition bill comes due.

Another example is your “rainy day” fund. Experts advise keeping a rainy day fund of 6-12 months operating expenses in case of job loss, unexpected health care expenses, or other unplanned expenses. Since these financial shocks are, by their nature, unexpected surprises, your rainy day fund is always in the holding season, and should always be in cash.

Divesting—wintertime, living off your nest egg.

 In the winter animals live off the resources harvested in the summer and protected in the autumn. Many animals hibernate, slowly consuming the resources they carefully put away in the summer. Even insects hibernate. They lower their consumption, live at a slower pace, and enjoy the peace that comes in the season of winter.

For investors, divesting resources throughout retirement is just as specialized and challenging as each other season. Reducing consumption and planning divestitures to minimize taxes are critical factors in making sure your money lives as long as you do. However, since you may expect to live 20 years or more in a comfortable retirement, you cannot simply move everything into cash. Some of your retirement funds must keep working in the financial markets to provide long-term growth for your later years.

Long-term divesting is really a combination of two other seasons—holding and long-term growth. Each year you move one year’s worth of living expenses from long-term growth assets into cash.  The remainder of your assets stay invested, providing long-term growth for later years.

Long-term Investments—Good Summer Crops

With an understanding of the seasons of investing, we can now describe some of the features of long-term investments that grow well in the summer season if investing:

Self-adjusting for future changes—let’s agree that we cannot predict the future. For those who can, this article is unnecessary. Ideally, our long-term investments should be self-adjusting. They should accommodate changes in inflation, employment, and the inevitable business cycles. For instance, some bonds, such as TIPS, have interest rates that track inflation. Rental rates on some investment properties tend to track inflation. Dividend yields on some large-cap stocks tend to track inflation. No investment is perfectly self-adjusting, but some are much better than others.
Long time horizon—Since most of us have careers and families, we don’t have the time or interest to track our investments daily, or even monthly. Investments with long time horizons give us the freedom to make adjustments only a few times each year. Any investment with an expiration date is suspect.

Low volatility—Volatility, also known as beta, is simply how much the price bounces around. Investments with high volatility include most short-term trading vehicles, such as foreign exchange rates (forex), commodities, options and futures. High volatility increases the premium on good timing and increases the penalty for bad timing. But, even assuming the investor gets the timing right, highly volatile investments tend to increase stress and lead the trader into ever riskier trading. Not a strategy for long-term growth.

Forced savings—Some investments have built-in savings reinforcers. Automatic monthly purchases of mutual funds, paid by automatic withdrawals from the checking account, build the habit of saving. Likewise, automatic payroll deductions for individual retirement fund deposits make saving regular and easy. A fully-amortized mortgage payment for income property has a principal payment built-in. Each of these reinforces the habit of savings and uses the power of compounding to achieve long-term growth.
Tax advantaged—Taxes consume a significant portion of any return; and taxes may increase in the near future, to pay for all the new government expenditures. Some investments increase overall return by providing tax deferral as well as current income and growth. Retirement funds are the shining star of tax-deferred investments. IRA contributions are not taxed when made. Thus, the investor has an interest-free loan from the government until the money is withdrawn many years later. Real estate investments also can provide some tax deferral.

With these few guidelines, you can identify good investments for your own summer of long-term growth. Best wishes for a bountiful harvest.

By RBS Homes, www.RBSHomes.com