Record Bull: Time for the Prevent Defense?

With football starting this week I thought I’d talk some defensive strategy. Namely, the prevent defense – pronounced, inexplicably, preee-vent. For those of you new to this, the prevent defense is often employed by teams with leads more than 3 points and less than 8 with just a few minutes to play. The theory is bend, but don’t break. More specifically, you put just 3 down lineman to pressure the Quarterback and 8 Defensive Backs to cover receivers and prevent a deep pass from reaching the end zone. The result is the offensive team often completes a flurry of passes for 10-15 yards, while burning valuable clock, but never reaches the end zone.

For us fans, the preee-vent can be maddening. We ask, the defense has been stopping them all day, why change now? But, there’s a reason coaches do this: it works. A good rule for football and investing is never take on more risk than is necessary to get the job done. In football, one bad play can ruin a game. In investing, a down market at the wrong time can ruin a lifetime worth of saving if you’re not prepared.

As a Kentucky fan, think back to last year’s Florida game and allow yourself to remember that feeling for a moment. That feeling is what we’re trying to avoid in our investing. As a recap, we beat Florida like a rented mule through three quarters. Then, it happened. Florida scored not once, but twice, in the fourth quarter to erase a big lead. Two plays turned a 27-14 Kentucky lead into a 28-27 Kentucky loss. Not only did we lose the game but that loss was the difference between a good season and a great one.

Record Bull Market

Last week marked the record for the longest Bull Market in history– it hasn’t declined more than 20% in over 3,453 days, the old record. That’s more than 9 years of a rising stock market. It’s enough so if you’re younger than about 40, you may not even remember the stock market crash of 2008-09, at least in personal terms, because you probably didn’t have much to decline at that point.

So, inevitably, people are asking: When will the market decline appreciably again? Should I prepare for a down market? What if I move out of stocks and miss 2 more years of an up market?

Timing the Market

If you’ve ever read one of my posts or talked to me about investing you know my opinion that any attempt to time the market is a fool’s errand. Why? Because it’s impossible. No one can tell you when the market is going to decline and, equally important, when it will rise again. Even Warren Buffett admits it can’t be done. Get this:

If you bought into the stock market on January 3, 1995 and sold your holdings on December 31, 2014 – 20 years – you would have netted a 555% return, or 9.9% annually. Remarkably, that gain even includes two precipitous drops – 49% drop in 2000 and the 57% plunge in ’08-’09.

Now, the real lesson here: If you had tried to time the market by selling your stocks or mutual funds and missed just the 10 best single-day performances of the market over this 20-year period, your return would have gone from 555% to 191%. Miss the 30 best days and the entire 555% is gone. Clearly, timing the market does not work.

Protect Your Gains

When the Great Recession hit and the stock market tumbled over 50% in 2008-09, there were two types of investors. Those who were prepared for market ups or downs, and those who weren’t.

If your portfolio was split 50/50 between stocks and bonds, your portfolio would have lost about 29% in value during the crash but gained it all back in about 1 year.

If your portfolio was 100% in stocks, it would have taken you about 3 years to claw your way back to even.

What I Did

I recently decided, in consultation with my financial advisor Ramsey Bova (yes, everyone needs help with these decisions, even us advisors) to de-risk our portfolio. Not because I’m predicting how the market will behave but because Lisa and I don’t need to take as much risk as we did when we were younger and had less. So, we decided to sell parts of some of the mutual funds that have gained a lot and take those profits and invest in safer, more stable investments. Why? Because the approximately 4.5% yield that we will receive from these new investments will be more than enough to meet our goals. Why take additional risk in search of 3-4% more return if it’s not necessary?

Your Personal Rate of Return

Again, I firmly believe no one should take more risk than is necessary to achieve their goals.

In football, Kentucky simply needs to outscore Central Michigan this Saturday to win. For our clients, our mission is to help them acquire wealth/investment assets sufficient for financial freedom. In other words, they will have enough money to cover their needs throughout the rest of their lives. Their personal Rate of Return is the return necessary for them to reach their financial freedom goal.

For someone in their 30’s or 40’s that Rate of Return needs to be larger than for someone in their 50’s or 60’s. As you know, trying to achieve more return requires more risk. Two examples:

1. If you are 40 and shooting for your financial freedom by age 60 or 65, you can and should take on more risk because you require larger returns. So, your portfolio should contain assets intended to grow combined with a few investments designed to be steadier and hopefully not decline when the market does. In football terms, be aggressive on offense and defense because you need to put points on the board and bank them for the 4th quarter.
2. Now, if you are say, in your mid-50’s or 60’s, and have accumulated just about enough wealth/investment assets for your financial freedom, why on earth would you take unnecessary risk? In football terms, it’s the 4th quarter and you have a lead, get into that preee-vent defense. Trust me, the market will decline at some point. Warren Buffett and I don’t know when, but it will, and you should protect what you’ve worked so hard to accumulate. Don’t get burned by the deep throw!

Many fans hate the preee-vent defense and any coach who wants to keep his job won’t employ it in the 1st or 2nd quarter. But, done correctly and at the right time, the preee-vent defense can save a team from disaster. A financial plan designed specifically for you can determine when you should throw the deep ball to put points on the board and when you should concentrate on protecting the points you already have.

Steve Byars

‘Cats by 90!