I used to play Monopoly as a young boy with my best friend Eric. In those primitive pre-computer days, we engaged in epic battles as we played the role of real estate mogul, buying and selling properties and rolling the dice. At a key point late in the game, when Eric landed on a valuable property that could tip the scales and create a vital monopoly, he would pull $500 of Monopoly money out of his pocket that he ostensibly had stashed earlier in the game, for use in just such an occasion.
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I don’t know if Eric had really stashed the money up front, or whether he stole the money from the bank while my head was turned, but I stored the experience for future reference. I used my experience with Monopoly to create a new saving strategy: the 20 Percent Solution.
First, a little background:
Even casual observers know that the stock market, like the weather and hairstyles, goes through cycles. Endless approaches have evolved in an attempt to capture the updrafts and avoid the downdrafts. Some are simple concepts, like “buy and hold.” Just ride out the ups and downs, this theory says, and over time, you’ll do well. Indeed, time has proven this approach to be effective, at least if one actually has the patience and perseverance to follow it through thick and thin. The challenge is that human nature works against us. When things look grim and the market is crashing, the discipline of “buy and hold” can feel like a course in “Going Broke for Dummies.” Investors often bail out because the stress becomes too much to bear. So the question is, are there other reasonable approaches to dealing with market cycles? I think there are, at least to some extent.
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The price that the market is willing to pay for a business, as expressed by market prices, varies over time. Sometimes the swings are dramatic and may be subject to strange fads. In the 1960s, for example, conglomerates were wildly popular. The concept was that a company that owned a diverse assortment of businesses would always ride out the business cycle because some companies would thrive while others struggled. Eventually the euphoria waned and conglomerates suffered because Wall Street analysts considered them “complicated” and “lacking in transparency.” They sold for discount prices and a cottage industry of “de-conglomeration” emerged, with the goal of breaking up these companies.
Fortunately, a number of measures are widely available to determine the overall price level of the market. These financial metrics are not so difficult to grasp, although they are beyond the realm of a short article. So know this: one can “take the temperature” of the market and know with some accuracy whether it’s running hot or cold. Right now, the market is at least a little on the warm side, propelled higher in part by economic stimulus. Sure, it may go higher, even much higher, but at times like these I advocate the 20 Percent Solution. This concept suggests you take approximately 20 percent of your money out of the market and place it in safe cash investments. Keep in mind, those dollars will earn next to nothing and even lose a little bit to inflation. But eventually the cycle will turn again, and when we enter the next down cycle, you’ll have some spare cash in your back pocket to invest when opportunity knocks. An opportunity is a terrible thing to waste.
Frank Jaffe is a certified financial planner and money management advisor with the wealth management firm of Access Wealth Planning in Roseland, N.J. He can be reached at email@example.com or 973-740-2400.
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