Answering critical questions key to managing risks Commentary

[caption id="attachment_18838" align="alignleft" width="108" caption="Charles Root"][/caption]

When you studied biology, you learned: “An organism either adapts to a changing environment or dies.” How does this apply to investing? Nearly the whole financial industry is set up for investing in a bull market. As a result of this bias, the belief systems developed by Nobel laureates about Modern Portfolio Theory, MPT, and the Capital Asset Pricing Model, CAPM, etc., have ruined many portfolios. Sometimes theories work, sometimes they don't After all they are only theories not laws.

Currently, unless you’re like Rip Van Winkle, you know that we are in a bear market, and the value of stocks and bonds has gone down substantially in the past couple of years. One needs only to look at any index values at the end of 2008 to see that effect. Even with the partial recovery in 2009 and 2010, your accounts are probably still down from the peak in 2007.

In a bear market, risk management should be your primary objective. Staying with the market because it will recover is not a strategy and may lead to long-term losses that are hard to recover. Most investors do not have the internal self discipline to weather this kind of a storm.

To effectively plan for the future, as well as adapt to the new investment climate, one must look ahead and create a strategy that is multifaceted. To do so you must ask yourself these critical questions. At first, the questions do not seem to be related to your investing strategy, but stay with me. You need to have a focused view of the future to make critical decisions. I suggest that you look at these critical questions as part of creating the future you want. Otherwise, without a plan, you are at the mercy of the market, often whimsical legal changes, the unpredictable economy and everything else that will change in the future.

1) Is your estate plan up to date, which means have you reviewed or created a plan within the last two years? Yes I know we have a “broken” estate tax law at the moment, but it will be fixed. Your plan must be flexible to accommodate future changes and look ahead for at least three generations. An estate plan must include more than the basic trust and wills. You wouldn’t want to work during your lifetime only to have your estate taken by taxes and fees.

2) Does your retirement plan have specific benchmarks and dates for achieving financial independence? What is your definition of financial independence, as it is different for everyone. Our definition is based on having sufficient assets to create the income needed for an ideal lifestyle without touching the principal. How much risk are you willing to take, and how long are you willing to work to get there? Very important questions.

3) Do you have life insurance to cover your asset shortfall that would occur if you died tomorrow in an accident? Your family’s security depends on sufficient income to continue their current lifestyle, and it should include planning for your children’s education.

4) Do you have a personal cash flow plan that includes all parts of your plan and creates a family legacy for the next three generations? Cash flow is the lifeblood of a business and your personal business of wealth building. Each time a cash flow decision is made does it include all parts of your plan or strategy?

5) Are all your advisers involved in creating your plan? Each should have input to their specific specialty, and you should designate one adviser as the group or team leader.

6) Does your investment manager have a written plan for your investments, including how to deal with the four market types to ensure your financial success? As was said in the beginning, most advisers focus on being in a bull market and do not have a risk-management plan. Risk management should be the foundation of your investment plan. Most investors focus on return or gain rather than on not losing asset value. If you don't take the long rollercoaster ride down, you don't have as far to come back when the market turns to offense. An investment policy statement is the key to growth and low risk, coordinated with the written trading plan of your adviser.

7) Do you put your head in the sand when the market gets volatile? You should be asking the tough questions that have been addressed in your written policy statement. Your future is too important to not be fully involved.

With an all-encompassing strategy, all the above five factors are included and more. If you haven't heard from your adviser within the last quarter, start looking for someone who will address all the tough questions you need for your financial independence.

Your future depends on critical questions. Be a results-oriented person who requires results.


Chuck Root, CFP, is managing director of Double Eagle Financial in Santa Rosa, 707-576-1313.