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Investing | By Philip C. Henry
Philip C. Henry, ChFC, CFS is the
President of Henry Wealth
Management, LLC, an independent
financial planning firm located at
1370 Washington Pike, Bridgeville,
PA. He offers Securities and
Investment-Advisory Services through
a non-affiliated firm, NFP Securities,
Inc., a Broker/Dealer, Member
FINRA/SIPC, and Federally Registered
Investment Advisor. He may be
reached at 412-838-0200 or at
Phil@HenryWealth.com. The firm’s
website is www.HenryWealth.com.
The Bear Headlines
As if the last six months of credit crises headlines weren’t enough
to cause even some long-term focused investors to consider short-term,
“fear-based” selling, the March 17 collapse of Bear Stearns, one of the
world's largest investment banks, amounted to a financial St. Patrick’s
Day Massacre.
Bear Stearns was founded in 1923 and grew into one of the
highest-regarded names in the world of international finance. At the
end of November, 2007, the Bear Stearns balance sheet listed total
assets of more than $395 billion, of which more than $35 billion was in
cash and nearly $264 billion was allocated in what were considered
“long term investments.”The latter category included a variety of
mortgage-backed securities. (Source: finance.google.com). Liabilities
listed included $383 billion in total debt.The bottom line is that Bear
Stearns had $11.8 billion in “equity” (assets minus liabilities). Even a 4
percent drop in the company’s long-term investments could
significantly impact its financial stability!
Poor Market Timing
Less than a week before the Bear Stearns debacle, Jim Cramer, the
host of CNBC’s Mad Money, was asked by a viewer: “Should I be
worried about Bear Stearns in terms of liquidity and get my money
out?” Cramer’s response, with the knowledge that Bear Stearns stock
was then trading at $63 per share (down from more than $150 per
share as recently as May 2007), was, “NO, NO, NO - Bear Stearns if
fine. DO NOT take your money out - Bear Stearns is not in trouble.”
(Source: CNBC.com).
On the contrary, Bear Stearns was indeed in deep trouble. On
March 17, the night of the collapse, Cramer did an about-face,
recommending that his viewers sell most of their financial stocks. At
that time, the remains of Bear Stearns seemed likely to be acquired by
JP Morgan Chase for a paltry $2 per share, in a shotgun wedding
brokered by the Federal Reserve. Hopefully, the Cramer-faithful did
not follow his advice on that day either, since JP Morgan Chase
increased its offer from $2 per share to $10 per share.
Poor Diversification
Not only would Cramer’s disciples have suffered by following his poor
market timing advice, but it appears that even Bear Stearns chairman
James E. Cayne, was over- extended in his own company’s stock.Mr.
Cayne lost nearly $1 billion in vested, yet unexercised, Bear Stearns
stock options. (Source:Wall St. Journal) These are shares that he could
have previously sold and re-invested in a diversified portfolio. Perhaps
he held on to the stocks in an attempt to minimize taxes, or maybe he
believed that a concentrated Bear Stearns position offered superior
upside compared to a diversified portfolio.
If the chairman of a major financial institution, possessing
presumably vast knowledge of the financial markets, could lose $1
billion falling prey to an undiversified, dare I say, imprudent approach,
what could happen to the average Joe, who may have a significant
portion of his wealth tied to a single or limited number of holdings,
not fully comprehending its inherent risks? The average Joe’s loss of a
few hundred thousand, or even a few thousand, could be more painful.
The Strategic Trio
What is the moral of this story? It is the same that I often write about,
this time surrounded by new headlines.The lesson is to base long-term
investment decisions on the following strategic trio:
• Asset allocation (determine an acceptable ratio of stocks to fixed
income holdings)
• Diversification (across many types of stocks and bonds)
• Rebalance Annually (to maintain desired ratios)
While asset allocation, diversification and rebalancing do not guarantee
against losses, this time-tested trio can certainly aid in shrinking the
volatility that may accompany a portfolio centered on a single, or
possibly a few, holdings only.
Stay tuned…very soon another monster headline will most likely
emerge, propelling some investors into making an additional round of
irrational decisions.Those who have created a sound, long-term
investment strategy will be able to rest easier, despite sensational
events.
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Hurdling to Victory
