Sunday, November 6, 2011

Your life is about your choices

When the market corrected savagely last September, I made a major strategic shift in my portfolio. As mentioned on this blog, I advised older investor to reduce risk levels in their portfolio. I also mentioned before, that most stock market risk lies in short term volatility and that over the long term the true fundamentals of your investments will determine its real return on investment.

The choice in September for me was, do I want to risk going through another 2008 and wait yet another three or four years just to recover to the levels of wealth earlier this year OR...

Do I sell off my riskier holdings and sit with a big pile of cash on the sidelines, waiting for matters to clarify? If I sell I may even have the chance to buy back in at much lower prices and realize a tidy profit! Of course, if the potential crash does not materialize, but instead there is a market upturn, I would have sold at the bottom of a savage correction and lose out on part of the recovery rally to follow.

That is the trade-off. Of course, this sounds awfully similar to market timing or even worse, panic selling. The pure ‘buy-and-hold’ investor may have grimaced at my move, but for me it was a re-allocation of my assets at an unfortunate time.

I finally realized that I was having a too high risk level in my portfolio that ‘prevented me for sleeping at night’. As a semi-retiree, I need cash flow to live from and my portfolio was throwing off only modest amounts cash flow and I was counting too much on possible future appreciation. There was not enough income to build up a cash position for buying new investment opportunities and too lead the lifestyle I like.

This summer, we had a family vacation in a nice resort Whistler; last week I spend moseying around in Canmore and next week I’ll be visiting my father, brothers and sisters in Holland. I helped my kids to buy their first cars this month and my wife and I are considering a vacation trip to Europe next spring, not to mention a cruise to the Caribbean around Christmas 2012 with family and friends. Oh, and my car lease is about to expire and I may need (better said – I want) a new one.

These things cost money – cash! Not to mention the cash my portfolio requires. So it is important at this stage of my life to forego rapid appreciation and focus on capital preservation and cash flow. Even more than ever before! 

It is my lifestyle combined with my peace of mind that in September made me decide to not wait out a potential market crash, but rather readjust my portfolio to reflect my needs rather than fulfilling the desire of a potentially higher ROI. Had I realized this 6 months earlier, I would have locked in less losses from the peak (or better larger profits on investments bought many years ago) than when I finally acted in September.

Why the slow response, if I already knew in May that my portfolio did no longer fit my lifestyle?

The answer: I chose to procrastinate; I was greedy and I didn’t want to give up on even more potential profits. I was a pig who got slaughtered! Well, I was a piglet and I did lose a limb instead of my investor life. But nevertheless, I paid the price for my choice.

There always will be risk in any investment. It is just a matter of choosing how much risk is right for you. A good way to figure that out is first of all, a rational assessment of how much cash flow and what total return on investment you wish to pursue and with what time horizon. But the real fire test regarding your current risk tolerance shows up during the next down turn like it did for me this September when I started to get that nasty feeling in my stomach and had trouble 'sleeping'. My and your investment results are not to be blamed on macroeconomics or on how corrupt management is, the results stem directly from our investment choices.

Whatever we harvest in our lives is a result of the choices we make. Consciously or unconsciously! Do you save or spend? Do you party or study? Do you buy that new car or a GIC? Do you swim or smoke? Choices big and small, made early or late in your life combine in your ultimate lifestyle.

Governments choose to promote home ownership amongst low income citizens by encouraging banks to lend out subprime loans. The greed of the bankers led them to choose to issue subprime mortgages and package these mortgages into structured investment vehicles and collateral debt swaps. Insurers like AIG choose to be counter party for the swaps. And then there were the low income earners who decided to take on the subprime mortgages and home owners who decided to take on more debt to finance their vacations and other lifestyle choices. It all led to a major event of reckoning, the culminated result of our poor choices – the 2008 financial crises!

Life is about choices and we benefit from or pay for our choices both in our personal lives but also in society. The choice by many Europeans to elect governments that advocated extensive social networks creating a culture of self-entitlement combined with the vicious fall out of the financial crisis and the imbalanced trade accounts of the BRIC countries with the rest of the world led to the misery of the European debt crisis. So next time when you make a choice, think about how it may affect your life not only short term but also long term.

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