Analyze
At the end of the day, says Matt Bacon, “the market is not the economy.”
“A lot of people try to focus on what’s going on in the economy to predict what’s going on in the [stock] market,” says Bacon, president and CEO of Tulsa-based HoganTaylor Wealth, a fiduciary wealth management/financial planning firm and subsidiary of HoganTaylor.
“But the market is irrational because of the investor,” Bacon continues. “That, in turn, makes it difficult to predict what is going to happen.”
Rather than trying to predict every market swing, financial advisors say investors are better served by focusing on strategies they can actually control.
The stock market is part art and part science, says Rich Howard, who along with Todd Welsh is a founding partner of Scissortail Wealth Management in Tulsa. That philosophy shapes the way advisors encourage clients to think about investing – not in weeks or months, but in years.
“It’s not timing the market, it’s time in the market that generates success,” Welsh says. “Even in today’s world, we cannot know all the factors out there that are going to affect the market. We won’t be aware of a COVID situation, for example, or that an Iran conflict is going to start, or all the things that vastly move the market in big ways.”
Welsh, who is a Certified Financial Planner and Investment Management Analyst, says that “it’s important to try not to get too focused on short-term volatility. Ideally, if investing in stocks, a time horizon is five to ten years or more. We don’t want to get overly concerned with gyrations in the market.”
Very few, if any, investors have proven they can make money on short-term bets, Welsh says.
“The odds of making money go up dramatically with a longer holding period,” he adds.
Factors investors should be aware of include inflation, interest rates and economic data.
“Inflation can be a hindrance on where we are today in the market,” Howard says.
“Inflation means there are fewer goods, and a bunch of people trying to chase that limited number of goods. We try to fight that with interest rates. That makes the cost of capital more expensive to businesses,” Howard says. “The market follows earnings most of the time. There’s a relationship there.”
Higher interest rates, Welsh says, are not market-friendly, nor is higher inflation.
“We would like to see the economy kind of churning along, not too hot and not too cold: a Goldilocks economy,” he says.
But even when people are invested in situations where the market is bad, “as long as you hold those investments, you come out with really good returns,” he continues.
As far as chasing hot stocks – a share of a company that experiences a sudden surge in trading volume, public interest and rapid price increases – is concerned, “what goes up must come down,” Howard notes.
For their clients who like to take a few risks, Welsh says, “we like to advise them to keep the largest percentage in their core portfolios. If they want to take a risk, they can use three to five percent to take some risks.”
Research
Choosing investments requires more than following headlines. Understanding a company’s financial health is essential, but that’s often easier said than done.
In fact, such research is difficult for the average individual.
“Most people do not want to spend the amount of time it takes to research those investments,” Welsh says. “We do the research for our clients.”
Potential investors can read reports available from large brokerage firms that offer opinions as to whether to buy, hold or sell certain stocks.
“But if you want to dive into it personally, you will have to understand balance sheets and cash flow and really complicated accounting,” he says.
And financial statements, Howard adds, look backward.
“They show what happened in the past,” he says.
That’s why professional investors combine historical performance with forward-looking expectations when evaluating a company’s potential.
“If we are going to research a company, we break it down on a valuation metric, to look at the company’s fair value versus where it is in the marketplace,” says Welsh. “We look at return on equity, return on assets, the balance sheet, the amount of growth it has, and what has been its growth rate. If it’s undervalued, it might make sense to own that particular investment. Investing is about future expected return.”
Scissortail Wealth Management helps clients create portfolios that correspond to their overall risk tolerance.
“A lot of us have similar research methodology,” Welsh says. “Ours is centered around diversification to decrease risk while maintaining a diversified portfolio. Things can happen at a frenetic pace to make a company grow or decline rapidly.”
Many of those principles are echoed by investor education organizations. The nonprofit Better Investing suggests investors choose companies that can survive downturns in the economy and the occasional business misstep.
“We look at the debt ratio to ensure the company isn’t overleveraged and then we examine profit growth for reassurance that the company has cash flow to continue to grow and build shareholder wealth,” according to BetterInvesting.org.
Diversify
Portfolio diversification helps manage risk by spreading that inherent risk of the market across multiple companies, multiple industries and multiple countries.
“If you own [stock in] an individual company, you are taking on the geopolitical climate and management of that company,” Bacon says. “If I own a thousand companies, I am not necessarily worried about what happens to any one company. I am spreading across multiple markets to decrease overall risk.”
Individual stocks have a much higher volatility than the overall market does, says Welsh.
“A high-tech stock might be up or down 50% in a year,” he says. “The more stocks you own, you get a blended volatility of all those stocks instead of one.”
The stock portion of a portfolio, he adds, “is there to grow your wealth over time. The cash and bonds portion is there to provide income and stability while taking much less risk.”
Howard says investors who focus on rewards often take more risks than they should.
“We are their risk manager,” Howard says. “We try to make sure they understand the risk they are taking.”
Welsh says his company typically likes “to use stocks for five-to-ten year investments and cash and bonds to lower portfolio volatility and provide income.”
He adds that diversification is a good thing in most cases.
“There are a lot of ways to achieve it. It’s important to pay attention to the expense of the investment you are going to utilize.”
Bacon says portfolios managed by his company typically offer a combination of stocks, bonds and alternative investments.
“Stocks are the most risky,” Bacon says. “Bonds are a safety net.”
And even within the bonds an investor holds, diversification is important. Government bonds, company bonds, high-yield bonds, convertible bonds and municipal bonds all contribute to a diversified portfolio.
“When I talk about multiple markets, I mean you want to own multiple countries,” Bacon says.
The U.S. harbors four percent of the population, but it’s the world’s largest consumer market, Bacon says.
“We must go out of the country to do business to satiate that demand,” he concludes. “We want to own the largest and the smallest companies. The majority of businesses in the world are small companies.”
Review
Building a portfolio is only part of the process. Keeping it aligned with changing markets and changing life circumstances is equally important. Investment portfolios should be reviewed regularly, financial experts say. But when and how much to rebalance “depends on each investor’s financial situation, personality and ability to accept risk,” says Howard.
Welsh continues: “In general, the older clients get, the more conservative they tend to get. But that is affected by a client’s personal situation.”
Investors at any stage in life should take risks only “if they have their conservative bucket full,” Howard says.
“If you have a portfolio that is 70% stock, and 30% fixed income and cash, then the stock is growing faster,” Welsh adds. “By not doing anything, your portfolio has become more risky than you intended it to be. When your stock percentage goes up, you can rebalance back to 70/30, putting some investments in the stock market back into cash. By reviewing regularly, you are able to see some of the investments that aren’t performing as well. You might need to sell them.”
Rebalancing helps his clients have a more successful investment experience, says Bacon.
“When you are thinking about deploying your capital, investing and saving, it’s always important to focus on what are your short, intermediate and long-term goals,” he says. “That is, ultimately, going to drive your strategy for how you deploy your capital and everything else you do in life. I tend to recommend a purposeful planning approach to finances. Too many people focus on the outcome first rather than why they are investing. As a result they take too much or too little risk.”
When people consider their financial futures, Bacon says, they tend to think in a linear fashion based on such typical stages of life as getting married, having children, starting to invest and retiring.
“But life doesn’t operate that way,” Bacon says. “We hit speed bumps along the way.”
Bacon uses himself as an example. Twelve years ago, he was diagnosed with Stage 4 colon cancer and given less than two years to live. He obtained a second opinion and his prognosis improved, but that “speed bump” caused he and his wife to adjust their financial goals “to do things we wanted to do later in life, today.”
