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How do I survive the catastrophe du jour?

By Jim Pratt-Heaney

You wake up early and turn on the television. The Middle East is imploding, gas hits $4 a gallon, a major earthquake strikes Japan, followed quickly by a tsunami killing thousands. Dow futures are down 280 points, Japanese stocks have lost 10 percent of their value overnight, and the talking heads are jabbering excitedly. And this is before you even have your coffee.

Is this the start of another recession before we have even exited the economic collapse of 2008? Is inflation rearing its ugly head? What should I do with my investments? My safe municipal bonds are now making headlines and have become less liquid; stocks that have finally come out of the decade-long swoon are just starting to feel better, and now this?

A historical perspective might be helpful here. Looking back, the Russian economic meltdown and Long-Term Capital implosion were big market-moving events. So were 9/11, the subprime crisis, the two Gulf wars, and the Internet bubble, to name a few. While each event, especially given the current saturation of cable television’s 24-hour coverage, can be very scary and seem to be “the worst ever,” our response as advisors to our clients and their families has remained consistent and is as relevant today as it has been in the dozens of high-profile, market-moving tragedies of the past decades.

Principle One

Have a family blueprint in writing, showing how your assets are optimally positioned to meet your short-, intermediate- and long-term goals. Coastal Bridge Advisors’ “Family Goals-Based Planning” article in the August/September 2010 issue of Worth is available by contacting our client communications team.

Principle Two

Rebalance your investment assets by risk category, asset class and management style. After major moves in various asset classes, it is important to rebalance to your target allocation. If stocks are supposed to be 35 percent of your portfolio and drop to 30 percent in stressful times, have the discipline to increase that asset class to meet your family plan. In the same way, you should be reducing stocks in great markets when they rise to 40 percent of the portfolio versus the plan’s 35 percent target. We typically recommend rebalancing annually, but in very volatile environments you should do so more often.

Principle Three

Remain calm. Well-prepared investors should have plenty of liquidity in very safe, cash-like instruments to sustain their current lifestyle for a minimum of a year and perhaps as many as 10 years, depending on personal objectives and risk tolerances.

Set Emotions Aside

Why do investors typically underperform an index? Assuming an appropriate asset allocation plan is in place (diversification in styles, geography, managers and appropriate weightings for each security), what is the dominant problem for most investors? Emotion.

Robert Schiller wrote in the 2003 edition of the Journal of Economic Perspectives that market bubbles are caused in large part by the irrational exuberance exhibited in the mass psychology of investors. Individuals process feedback from recent events, which in turn causes systematic biases in their judgment of future events. With the onset of more information and media, Schiller argues that markets may become more volatile as investors respond to world events and adopt strategies that are either too optimistic or pessimistic.

June 2011