Warren Ward Associates

Dining Room Economics

My in-laws are wonderful people from several perspectives. They welcomed me into the family 39 years ago, raised eight children and are now comfortably retired following a lifetime of saving and investing. I am in no way surprised that they have been successful investors as they began teaching practical lessons in behavioral economics right at the dining room table.
 
Behavioral economics, you may remember, is the study of why people - regardless of their education or sophistication - sometimes make less than optimum financial decisions.
 
The past eighteen months have given us an perfect example of behavioral economics at work, albeit one that I certainly hope isn't repeated anytime soon. Although none of our clients chose to take their money out of the markets during the recent correction, several of them called asking for reassurance that remaining invested was truly in their best interests. Other individuals with whom I spoke had chosen to withdraw from the markets and they too wanted confirmation that they had made a good decision.
 
Investment management firms like Warren Ward Associates are staffed by human beings who are in no way immune from experiencing fear. However, our clients depend on us to process that fear very carefully before responding to it. In the case of both the 2000 and 2008/9 corrections, we avoided making a fear-based decision to sell. We kept our clients in the markets, thus allowing them to participate in the subsequent upturns.
 
The decision to sell stocks and bonds (i.e. leave the market) necessarily involves two different steps. First - obviously - is choosing the right time to sell. As fear levels increase, people are more likely to take that step. When fear reaches the point that the idea of actually taking a loss becomes more appealing than worrying about how much more might be lost, they act. Once that happens, investors face the second decision: when should the money be returned to the markets? A fairly common answer is "when things look better" but using that rationale guarantees that the investor will have sold low and bought high (or at least higher). This is one of the very few life situations in which generally rational people resist buying things which have gone "on sale".
 
Such apparently irrational decisions led researchers to study behavioral finance. A very simple example involves two people being asked to play the "ultimatum game". The players are known as the proposer and the responder and each starts with no money. The proposer is given a sum of money to be shared with the responder in the proportions of his or her choice. However, neither gets any money unless the split is agreed to by the responder. Logic would suggest that any split would be a good one since, regardless of the percentage the responder might receive, it is greater than nothing. As the game is played, however, it is common for the responder to reject any offer very far from 50:50, even though such rejection means that neither player gets any money. Whether that response is driven by a sense of fairness or the same fear of loss that makes people decide to sell investments below cost, the most common response isn't a rational one.
 
By standing between investors and their investment decisions, planners can ask their clients to pause and reconsider their fear-driven urges, encourage them to take the longer view and try to help them achieve better long-term results.
 
Incidentally, in case you were wondering about my in-laws' dining room lesson, it was really quite simple. The family rule was that one child got to cut the dessert, then another choose the first piece. Behavioral economics at its most basic level.

As Seen on TV

Not too long ago, I saw a program on CNBC about selling via infomercial. Even though I’ve never availed myself of the opportunity to “act in the next five minutes and enjoy free shipping”, I found the show interesting. It featured Ron Popeil and others who invent clever gadgets and then make infomercials to sell them to the rest of us. The show made the point that infomercials are typically well produced making each item offered appear useful, unique – and unavailable elsewhere. Of course, without a great infomercial, the products would never sell.

I am not a gardener but I have heard that a tomato plant which produces ten pounds per season is doing pretty well. A friend went to visit his father the other day and noticed two shot glass-size cups on the window sill. When he asked about them, he learned that they were tomato plants which, according to the infomercial, could be counted upon to produce 60 pounds per plant per season. Time will tell if that particular offer meets expectations.

In addition to plants and pocket fishing rods, you can also find investment advice on television. Regular readers of my articles know that I don’t watch much TV but new acquaintances are sometimes surprised to learn that I don’t tune in to Jim Cramer every night to hear his investment ideas. Mr. Cramer was apparently a successful hedge fund manager (apparently because hedge funds are subject to very little regulation so their true performance is difficult to accurately determine) but, more critically for television, he is entertaining. According to research I have found, his investment advice has not been any better than average, although he certainly does make some good recommendations. The article I cited is not the only one which evaluates his skills. According to Google, the next most popular story about him comes from a source I consider to be one of his competitors, the Motley Fool. Like Mr. Cramer, that organization provides free investment advice in order to bring viewers to its articles and website. Those viewers make it possible for the Motley Fool organization and CNBC to sell advertisements. Of course, there’s nothing wrong with selling ads but when that’s the reason a site (or column or infomercial) exists, it certainly increases the value of an entertaining presentation.

You may be familiar with two additional sources of investment advice: Suze Orman and Dave Ramsay. Ms. Orman hit it big on Oprah but began her career somewhat more humbly, selling insurance in California. She now receives fees from the annuity products she endorses which makes me wonder if her advice can be truly unbiased. Mr. Ramsay offers very practical advice, then recommends local salespeople to implement his strategies. These individuals apparently agree to follow his approach in working with their customers but before buying from one, you might want to ask if any of their sales commissions are shared with Mr. Ramsay. While both of these nationally known figures have undergrad degrees, neither has earned professional certification in financial planning. That makes me a bit unsure about why their advice should be considered inherently more trustworthy than that available through any other infomercial, selling any other product.

Information is critical when making investment decisions. Whether you count on a guru or subscribe to professional publications, all the research in the world won’t guarantee success because investments don’t always perform as expected. Warren Ward Associates utilizes a “slow but sure” approach, employing the Nobel prize-winning strategy known as Modern Portfolio Theory. We have always agreed with famed economist Peter Bernstein that the future is unknowable, so we allocate investments among a range of categories. The downside of this approach is that if one segment does extremely well, i.e. technology stocks in the late 1990’s or housing stocks in the recent past, our clients are going to miss out on some of the excitement. On the other hand, when the inevitable correction follows each bubble, our clients receive protection through the diversification, again avoiding some of the excitement.

I believe that most people who offer free advice do so in hopes of selling something, whether it’s products for the home or investment products. WWA’s only source of compensation is the fees paid by our clients, so our advice is never influenced by our desire to sell anything. If you’d like to receive unbiased advice, instead of a sales pitch disguised as advice, give us a call.

The Philosopher's Stone

Those of you who were better history students than I may remember the philosopher's stone from your study of the Middle Ages, although it was Van Morrison’s song of the same name which recently piqued my interest. The philosopher’s stone is a legendary alchemical tool, supposedly capable of turning lead into gold. In the view of some early scientists, even one as otherwise advanced as Sir Isaac Newton, it would provide its owner with enlightenment in addition to extreme wealth.

Clearly anything possessing the ability to turn lead into gold would have value literally beyond measure. But, in fact, I think a large number of us have cooperated to accomplish something quite similar over the past six months. Through our combined efforts, we have turned the lead of our investment portfolios into gold or, at least, have increased most account values considerably.

Following an up-and-down start at the first of the year, the market (as measured by the S&P 500) gained about 17.5% through the end of July. When I wrote back in November and December that we were going to remain invested on behalf of our clients, one of the reasons I did not include is that selling into a declining market requires not one but two decisions. After having chosen to sell, you have to decide when to buy back in. When I hear from people who are considering that step now, the usual reasoning is something like, “It looks as if the recovery is real.” The problem is, having absorbed whatever loss accompanied their decision to sell, they are now significantly behind the market and may feel the need to assume an overly aggressive approach in hopes of catching up.

It’s important to remember that stock markets are a leading indicator, that is, their rise predicts an improvement in the overall economy. I believe it’s too soon to say that the recession is over, thus too soon to declare that a long-term positive market trend has begun. Back in December, I quoted Warren Buffett’s comment: “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.” Greed is one of the primary drivers of people’s return to the markets. I have become concerned that those amateur investors who tend to do the wrong thing at the right time (or vice versa) are preparing to leap into a market that’s not yet ready to sustain significantly increased buying.

Peter Bernstein was an economist and historian whose writings I have followed for many years. He maintained that, regardless of the amount of information available, the future will always be unknowable. Even though some analysts claim to have forecast the market’s meltdown in response to the mortgage crisis, I don't know of any whose overall predictive successes are greater than chance. Thus I continue to believe that Bernstein is correct: it is impossible to predict the future, including market declines. Our underlying investment philosophy is to protect our clients from the worst of the market’s ravages through diversification. That has worked for us in the past and worked again during this most recent correction. One additional advantage of this approach is never having to decide when it’s the right time to get back into the markets.

That said, the further bullish sentiments spread, the more concerned I become. Although markets have made a good showing so far this year, I suspect that we’ll get at least one more pull-back so I am repositioning some of our clients’ assets in hopes of once again helping them avoid significant losses.

Unfortunately, the philosopher’s stone has eluded me just as it did the thinkers of the Middle Ages. I have achieved neither the promised enlightenment nor the ability to turn my clients’ assets into gold. However, I can safely reiterate our firm’s commitment to a strategy that tries to protect them from market-related losses while also allowing them to participate in market upswings.  Unless and until I obtain the philosopher’s stone this seems the most prudent course of action. 

Who is Charles Ponzi and Why Are People Saying Such Terrible Things About Him?

Our Securities and Exchange Commission (SEC) defines a Ponzi scheme as “a type of illegal pyramid scheme named after Charles Ponzi”. This, of course, begs the questions of who Ponzi was and how he came to the attention of the SEC. Back in the 1920s, Ponzi defrauded thousands of New England residents by helping them speculate in postage. He promised investors at least a 40% return every 90 days by taking advantage of the differences in value between U.S. and foreign currencies used to purchase international mail coupons. Again, the SEC: “Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period—and this was 1921!” Although he paid off the earliest investors to make the scheme look legitimate, subsequent investigations found that he had only purchased about $30 worth of coupons.

Ponzi was probably not the first to pull off such a trick but, 90 years later, we still use his name to describe schemes which use money from later investors to pay off earlier ones. These early investors inadvertently bring new investors into the fold by sharing stories of their success. At least “until the whole scheme collapses” (quoting the SEC one final time).

This past year has brought a spate of similar scams to light. Withdrawals are not a problem for the perpetrator as long markets are doing well. During bull markets, people are comfortable letting their investments (apparently) continue to grow along with the markets. However, when markets decline, people often decide to lock in some of those profits, leading to requests for withdrawals and the sort of implosions we have seen. The June 12th The Washington Post reported that the FBI had nearly 500 Ponzi scheme investigations underway.

These frauds sometimes feature recurring themes, such as an affinity group, to attract investors. Ponzi was an immigrant and played on his Italian heritage to bring in trusting investors. Bernie Madoff used his Jewish connections to do the same. In other ways they are different: Ponzi targeted uneducated investors, describing himself as a populist. Madoff famously catered only to the elite. Being a Madoff client carried considerable caché, at least until last fall when investors requested $7 billion and only about $200 million was available.

Ponzi offered to let people get rich quick, while Madoff promised consistent returns regardless of market conditions. Ponzi perpetrated his fraud before the existence of the SEC while Madoff basically ignored it. Both of them duped thousands of investors, neither actually invested the money they raised and both built unsustainable pyramids which ultimately collapsed.

Ponzi pleaded guilty to a federal charge and spent about 14 years in prison before being deported. Madoff pleaded guilty last winter to 11 felony counts of orchestrating a fraud. Apparently he told his sons that it would amount to $80 billion, although that probably includes fictitious profits in addition to the money originally invested. According to the records I’ve seen, very few of his clients were Indiana residents. This might be basic Midwestern conservatism at work or simply that his sales machine had not yet begun to focus on the heartland by the time he confessed.

Regular readers of my articles have heard these words before but in light of recent abuses, they bear repeating. If you encounter an investment which seems too good to be true, it almost certainly is.

At Warren Ward Associates, we begin the process of investing on behalf of our clients by asking two questions. First, who will buy this investment when it’s time to sell? And, second, if the safest investment in the world is paying a given percentage, what additional risks will our client have to take to earn some multiple of that? Our investment process generates wealth by reducing losses, not providing extraordinary gains. Our approach is strategic and evolves with the markets. It does not offer a way to “get rich quick” but then neither do most other investment opportunities, as Ponzi, Madoff and others so ably demonstrate.

Just Wait 'til Your Father Gets Home

Many things have changed since I was a little boy. Back when the post-war generation was raising children, my dad worked a full day downtown but my mom taught school and arrived home about the same time my sister and I did. You may be surprised to learn that I was not a perfect child and I sometimes needed to be reminded of that fact. The title of today’s article is something I heard from time to time – a warning from my mother that something really bad was going to happen and it wouldn’t be long in coming.

Thinking back, I don’t remember punishment being vastly different between Mom and Dad but I do remember the dread I felt while awaiting his return. I didn’t know what was coming but I was pretty sure I wasn’t going to like it.

If you recall similar emotions from your childhood, that might make the current market situation a little easier to understand. Market valuations have a tendency to swing too far in both directions, driven too high by our collective greed and too low by our fear. This time, an unsustainable market in home purchases, enabled by relaxed lending standards, created a “bubble” which has been popping in slow motion for the past year or so. At some point, even seasoned investors’ fear of “what’ll happen when dad gets home” overtakes their reason and they join the rush to sell securities, driving prices further down. They don’t know what’s coming but expect it to be bad.

According to the National Bureau of Economic Research, our country has had to endure 14 previous recessions with an average duration of about a year (10.5 months excluding the Great Depression, 12.9 months including it). These have proven to be great times to invest in stocks, bonds and real estate, a concept which makes perfect sense during the good times but is very hard to execute during the event. The other famous Warren in the investment world, Warren Buffett, once said that it makes investing easier to think of stocks as hamburgers. He explains that the investors for whom he works have always been net buyers of hamburgers, so buying them when they are cheap has proved to be a good strategy. He hates selling them when prices are low.

At recent levels, the stock and bond markets are priced in anticipation of a terrible event, something along the lines of the failure of all businesses. As scary as things are (and I am just as afraid as any of you who are reading this article), I don’t think that’s a likely outcome, at least in conjunction with the current recession.

Although Warren Ward Associates has adjusted allocations in those investment accounts we manage, we remain basically fully invested. Many headlines have questioned that strategy, suggesting that joining in the sales and moving to cash would be more appropriate. Since I am unable to predict the future I am forced to look to the past for guidance. The reason we have not sold meaningfully is that recessions always seem to end and market values always seem to return. The first year following the 14 previous recessions, stocks have averaged about a 20% return, bonds about 4% and cash a little less than that.

This time, as in the past, our allocation strategy has allowed our clients to do better (i.e., lose less) than the broad markets. That puts them in a better position heading into a period of recovery. As I look around, little peace of mind is to be found in the headlines or in conversation with friends. If that’s what you find too, let me ask you to consider the “when your father gets home” concept and remember that the sky is not falling, rainbows do follow storms and markets are quite likely to recover once again. As always, please feel free to contact Jalene or me with your specific questions.

. . . and all the children are above average

I have written before about what a mixed blessing averages can be. In trying to figure out how well a group of individual elements is performing, determining their average is a common place to begin. In my earlier comments about mutual funds, I stated that simply through calculating an average, one-half of the funds included must fall below it.

That’s not true, of course, in the case of Garrison Keillor's mythical Lake Woebegon, where all of the children are above average. Actually, thinking of oneself as above average is a pretty common bias. According to the invaluable Wikipedia, back in 1981, Swedish researcher Ola Svenson found that 80% of respondents rated themselves in the top 30% of all drivers. I understand that this situation has now become known as "The Lake Woebegon Effect".

Thinking only about averages, it might be easy to assume that insurance on your home is a poor idea. It’s not likely that any of you reading this article are deliberately without property insurance but, if you relied only on the averages in making your decision, such coverage might not make sense. You have a less than 1% chance of having your home burn in any ten year period and most people don’t know anyone whose home has burned. Yet, the potential devastation is so great that most of us, quite appropriately, have looked beyond the averages in making our insurance decision.

Investment returns are often expressed as averages. For example, the average rate of return for the Standard and Poors 500 over the past 75 years has been greater than 11%. Does that mean that all S&P 500 investors have done that well? Unfortunately, it does not. That famous index is as much at the mercy of "the market" as any other investment. One of the problems with average rates of investment return is that how well you do depends to a great extent on when and for how long your money was invested. If you remained on the sidelines then invested at the top of the tech stock "bubble" in 1999, your account only recently returned to profitability.

Mutual fund investing raises further issues. From their advertising, you might think that all of them were above average. Their rates of return are usually expressed as a percentage from one date to another but most people don’t earn even the published return, as they make their investments in a much more random way. At the request of the Securities and Exchange Commission, the mutual fund industry has begun to address this issue, trying to establish a more appropriate way to express their performance.

At Warren Ward Associates, we are aware of average rates of return, but our investment process places much more emphasis on such specifics as manager tenure and a fund’s ability to stick to their investment strategy than it does on returns. Understanding what has happened in the past does not guarantee investment success but it is a key component of our strategy of reducing risk while trying to provide "average" returns.

What Goes Up Must Come Down

In the early 1970’s, my wife and I took a vacation which included some international travel – driving across the border into Canada for dinner. Back then, the two of us could eat for less than $10. As I paid with a ten-dollar bill, I was surprised to see the cashier ring up $9.75. When I asked why, she explained to a very young and globally inexperienced tourist that the US dollar was worth less than the Canadian dollar. The restaurant’s owner didn’t care if someone used US change to buy after-dinner mints but the difference was noticeable in a larger transaction, so she was required to take the discount into consideration.

Since 1974, the US dollar has generally been the stronger of the two, as you can see by looking at the cover of a paperback book. In most cases, you will find two different prices, one for US currency and a second, higher one, for Canadian. As recent headlines have pointed out, the two country’s dollars are nearing parity for the first time in many years.

I have written before about the constant fluctuation in the relative value of national currencies. In a recent note, I linked to a chart from Wired magazine showing the retail price of gasoline in several countries – at least partially a reflection of currency valuations. Last year, I commented on the weakness of the Chinese yuan. This low value has made Chinese exports more competitive in the world market, helping the Chinese find customers for their goods, thus providing needed employment for their citizens. I also noted that currency fluctuations tend to even out over time, as a weaker US dollar makes our own exports comparatively cheaper to buyers in other countries. These days, many of the containers which arrive in the US full of finished goods are returned to China full of scrap. The weak dollar has made it cheaper for China to import paper, fabric and metal than to obtain needed raw materials from the earth.

Most of us who lived through the inflationary period of the late 70’s would prefer not to do so again. While a weaker dollar tends to bring jobs back into the US, it also makes those items we choose to import more expensive. Governments, like individuals, must earn more than they spend or they will find themselves going deeper into debt as time passes. If the United States continues to spend more than it collects in taxes, it must go on borrowing ever greater sums, continuing the trend to ever lower currency valuation. We have encouraged our clients to invest internationally in hopes of profiting from these fluctuations and our model portfolios now contain investments in both developed and emerging international markets.

Unfortunately, economics is as much an art as it is a science. You can easily find two well-qualified economists who believe the same set of circumstances will lead to two entirely different results. Because of that, both private citizens and politicians are almost always able to quote a famous economist whose view reinforces their own. Regardless of what economic strategy a politician espouses, it has been my experience that most are more interested in being reelected than facing and solving problems. They know that spending taxpayer dollars in their home districts is the quickest route to reelection, with more spending yielding more votes.

It will be pretty easy to keep an eye on the relative values of the US and Canadian dollars but our dollar’s value in relation to the rest of the currencies in the world is not quite so obvious. At this point, the trend I see is not a positive one. Perhaps our future will hold a balanced national budget, leading us toward a stronger currency and away from the risk of inflation. However, I suspect that achieving such an end will require a re-evaluation of the way we judge our politicians, perhaps leading to a less political way of making national spending decisions.

Swans a-Swimming

In his 2007 best-seller The Black Swan, Nassim Nicholas Taleb assures us that a pair of pure white swans, each from a long line of pure white swans, can produce a black offspring from time to time. He uses this concept of unexpected black swans to help describe sudden changes that take place in our world, especially in the investment world. He worked as a trader on Wall Street and marveled at the lengths that other traders, not to mention newscasters, went to in trying to explain the generally unexplainable events which affect those markets.                                                          

Virtually no one predicted the fall of the Berlin Wall. Yet, in hindsight, it seems so obvious that we are surprised no one got it right. All sorts of media, from newspapers to websites to TV commentators, offer us regular examples of a headline predicting one thing when, in fact, something else entirely takes place. In my experience, no segment of the media has a particularly good record of anticipating interest rate changes, inflation or market moves even though it seems that, with all the information at their disposal, at least some of them should be capable of greater accuracy. Here are a few predictive comments followed by a quick summary of what actually happened:

• Mid-October 1929 - "Stock prices have reached what looks like a permanently high plateau."

Yale economist Irving Fisher, (just days before the market crash)

• Nov. 6, 1982

  - "Sell all stocks. This is a bubble market, not the normal entrance to a new bull market. The recent rise of 37.1% in the Dow average in 12 weeks is the largest bet Wall Street has ever placed on expected economic recovery. It equals the final blowoff rise between June and September 1929."

Technical analyst Joseph Granville, (preceding the greatest upward market run in history)

• March 17, 1999

  - "How high will the market go? Our calculations show that with earnings growing in the long term at the same rate as the gross domestic product and Treasury bonds below 6%, a perfectly reasonable level for the Dow would be 36,000 -- tomorrow, not 10 or 20 years from now."

James K. Glassman & Kevin A. Hassett, in the Wall Street Journal

(the Treasury bond is now below 4.4% and the Dow is trading around 12,000)                                                                                                                                                                                                                                                                      

Keeping focused on long-term goals is the very essence of financial planning. When we become involved with new clients at Warren Ward Associates, the process of planning their investments begins with getting to know them as individuals, evaluating their experience and trying to gauge their comfort level with investing. It is especially important to us to evaluate how much volatility they might be willing to accept before we prepare a plan. These steps lead us to a personalized balance between stocks, bonds, CDs and real estate for each client. The point of this allocation process? To try to minimize the damage to our clients assets as a result of the black swans which the markets will almost certainly continue to have in store for us.

                                                                                                                      

Although our record on behalf of our clients has been good, success has not come through using special insights to predict what is about to happen. We focus on asset allocation in an attempt to avoid significant losses by hedging against those black swan events. When we are able to successfully protect our clients from the worst of the corrections, then the broad market up-sweeps have the ability to provide reasonable overall returns.

Tax Dates to Remember

I suspect that most everyone who reads my periodic comments about financial planning and investing is familiar with April 15th, tax day for most US citizens.

Another, less well-known tax date is Tax Freedom Day®, a date which has been calculated by the Washington DC-based Tax Foundation (www.taxfoundation.org) since 1971. For 2008, they figure it to be April 23rd, meaning that, on average, we work the first 113 days of the year to pay for our governments and their services. While there is legitimate debate about what this figure/date actually means, it is at least a stab at answering the question: "What does our government cost us?"

Income taxes have been imposed by most countries at one time or another but, in the United States, it took ratification of the Sixteenth amendment to make it clear that the federal government could legally do so. The first rate was 1% on yearly incomes above $3000 (about $60,000 in today’s dollars) with an additional 6% surcharge for incomes above $500,000 (about $10,500,000 today).

Services like police protection and maintaining a standing army appear to be here to stay. Even the staunchest advocates of "small government" agree to the need for at least some services which can only be provided by the government. These services, whether provided at the federal, state or local level, obviously require taxes to fund.

I avoid debates about the fairness of taxes, since I know I’m unlikely to influence the outcome. Instead, I try to help my clients understand the system and orient their financial planning and investment decisions to accommodate it.

Seventeen years ago, when I earned my first brokerage license, interest rates were relatively high and tax-free municipal bonds were often a very appropriate investment. As interest rates fell, we searched for a strategy to replace tax-free bonds in our clients’ portfolios. Over the past couple of years, we have implemented a process for selecting dividend-paying stocks which provide a similar result. Our clients receive tax advantaged income (in the form of dividends) but we are able to choose when to take any capital gains by deciding when to sell the stocks.

Recent changes in interest rates have made municipal bonds somewhat more attractive, so we have begun to consider that option again, at least for some clients.

When we choose managers for our clients’ assets (usually through mutual funds), one of our screening elements is tax efficiency. Different managers employ different strategies but we generally try to place our clients’ non-retirement assets with managers whom we expect to be able to minimize current-year taxation.

Here’s one final tax date to think about. On December 31, 2010, our current federal estate tax structure will expire and we will revert to the 2001 rules. The original estate taxes were enacted largely to help break up the huge family fortunes amassed by the early steel and railroad "barons". The effects of inflation eventually brought those taxes to bear on most middle class families. The 2001 revision of the law brought a phased adjustment, moving most of the middle class back out from under them. As this revision approaches its "sunset", debate continues about the fairest way to implement estate taxation.

I spend more hours in continuing education every year on taxation than any other topic. Our hope is to always be able to make suitable options available for our clients, regardless of what form taxation might take.

The “R” Word

Like most other professionals, financial planners live in a world which requires a high degree of accuracy. Columns of figures must add up, reports must be filed on time, details must be attended to. I almost said that words must have exact definitions but I’m not sure that one is always true. My wife and I recently watched a cute movie which followed a year in the life of some teenagers. Unfortunately, we didn’t understand the meanings of all the words they used. While we were almost always familiar with the words themselves, about half of the time we had never heard them used in quite the way they were in the film.

Since I’m not a high school teacher, being a little out of date on the latest teen-age slang is really not a problem for me. In the case of the movie, the context allowed me to keep up, even without understanding everything that was said. However, not staying abreast of words which are part of my professional language is a different story. The word I have in mind today is recession (sometimes referred to in our industry by the title of today’s article). People are sometimes afraid to say it aloud because just mentioning it might make it a reality, especially when uttered by an important government figure.

Recession is properly defined as "two consecutive quarters of negative growth in a country’s real gross domestic product", i.e. six months of reduced output. Headlines questioning whether we are in a recession have been a media staple recently (as of April of 2008) and I recently saw a website where a poll was being conducted to decide whether we were in one or not.

One of this era’s most successful money managers is Forbes magazine columnist Ken Fisher. In his new book, he questions the point of "asking people" if there’s a recession going on. In his mind either there is or there isn’t – per the definition. Although I usually agree with Mr. Fisher regarding investment issues, I’m not sure he’s right about this one.

I am a close observer of the activities of the Federal Reserve Board of Governors (the Fed), that group of bankers charged with keeping our economy on track. One of my regular concerns is that, at least under previous Chairman Alan Greenspan, they always seemed to be driving by looking in the rear view mirror. That is, they were waiting for data to be posted before making a decision - looking to the past to decide what to do about the future.

Although knowing exactly when a recession begins or ends might be of historical importance (or political importance in an election year), how people feel about the economy is probably more important to most of us. People tend to feel better about their lives when they are comfortable with the level of their savings, whether through increases in the value of their homes or their other investments. Naturally, the opposite is also true, with reduced assets bringing on concerns about their future. Many people incurred significant losses during the 2000 market correction which followed the "dot-com boom" of 1998 and 1999. In today’s market, however, most people are not going to lose their homes through foreclosure related to the sub-prime mortgage problem. Yet enough of us have become cautious in our spending that "the ‘R’ word" is being uttered. It seems as if the more it’s talked about, the more worried people become and the more likely a true recession might be.

How does this debate affect us and our clients? Very little, in fact. Although there are a few circumstances which would make us consider cashing out our clients’ investments, we have not seen any sign of them yet. We have faith in the process of asset allocation and believe it is possible to avoid the worst of a market correction by being properly diversified. Although we have made several recent changes in our client’s asset allocations, we continue to be fully invested and are likely to remain so, regardless of the latest poll declaring the presence or absence of a recession. Long term investing is what we do.