Suspension of Reality

Several years ago I placed a simple message on my bathroom mirror: “Do not give up what you want most for what you want now.” Of course, the phrase is not mine and is found throughout the internet and on motivational posters. But it is popular because the message is undeniable.

I mention that quote because it was the first thing I thought of when I “found” this article on my computer. Most of us know the truth when we hear it, most of us know the power of discipline and delayed gratification and unemotional decision making, but we all struggle to make it a consistent part of our behavior. Therefore, it never hurts to go back to the basics. I think this article is just as applicable today as it was nearly 10 years ago. And it will probably be re-printed 10 years from now with the same message.

Stay the course ….

Narwhal Capital Management

Revised June 14, 2010

“Suspending Reality will never make you rich”

Despite some encouraging financial trends over the past few months, investor uncertainty and pessimism seem to be reaching new depths. There’s only one way to get through the choppy spots, though, and that’s to boost your outlook with a few simple truths. In the market, as in human nature, some things never change.

• Simple Truth No. 1: Risk and return are inseparably linked. Picture a 19th-century locomotive and its coal tender. One goes nowhere without the other. Of course, the locomotive may decouple from the coal tender for a brief time (it happens in Western movies), but ultimately the big engine will be forced to stop. In similar fashion, various “new” and “sophisticated” market strategies may appear to produce excess returns without corresponding risks, but, in my experience, either the risk is masked or the strategy runs out of steam.

• During the technology boom of the 1990s, Garrett Van Wagoner was one of the rockstars of the mutual fund world. In 1999, the Van Wagoner Emerging Growth Fund gained 291 percent (from $189 million to $1.5 billion in one year). If you had invested $10,000 in the Emerging Growth Fund at the beginning of 1997, you would have cumulated $45,000 by March of 2000. Van Wagoner was hailed as one of the greatest investors of all time. Then, in 2000, the Emerging Growth Fund lost 21 percent, in 2001 it lost 60 percent, and 2002 saw a loss of another 65 percent. The $45,000 that had accumulated in 2000 would have been worth only $3,300 by the end of September 2002. Moral: The locomotive roaring around the mountain always faces the chance of running out of fuel, blowing up, or facing a rock slide with no time to stop.

• Simple Truth No. 2: Never forget the long term. In an age of microwave popcorn, movies-on-demand, and instant news updates, we are plagued by time compression and information overload. One quarter has a sense of finality – the concept of years or even decades spent holding on to investments seems anachronistic. A finance professor once offered his investment services to a class of graduating seniors: If they paid him $1,000 upfront and signed an ironclad agreement to follow a handful of mundane, financially conservative tips, he could guarantee that one day they would be considered rich. Really rich. But the catch was this -- they would also be old. No one was interested.

• We all want wealth, but we also want to be young. In our haste, we overreach, exposing ourselves to more risk than necessary, refusing to acknowledge the truth that real wealth takes time. Put that on your morning mirror.

Do you really want to make a big move in the get rich quick game? Assess the risks before jumping forward – don’t let the glitter of future riches blind you to the potential costs. On the other side of the coin, before you sell anything, check to make sure that all of your bases are covered. Reduce your debt as much as possible. Weigh the liquidity of your investments. How hard is it for you to monetize a large portion of your portfolios? Diversify your forms of cash flow. Investment income is good, but investment income that comes from multiple sources across multiple asset classes is ideal.

• Simple Truth No. 3: Asset diversification is like a vaccine against major capital destruction. Too often, either through overreaching for return (the politically correct term for greed) or through complacency, investors lose perspective of what constitutes their entire portfolio – the risk exposures they have and the concentrations they harbor. Investors naturally invest in areas where they are most comfortable, and they tend to over-concentrate in those areas that they have succeeded in. Better to take a disciplined approach. Classify your entire portfolio into five major components (The Big Five): cash, fixed income, stocks, real estate, and tangible investments. Assign a percentage weight to each. For most investors, each asset class should represent at least 10 percent of the overall portfolio. At a minimum, recheck your allocations semi-annually. Avoid the marketing machine of Wall Street when it presents a new “asset” class that it recommends make up 5, 10, or 20 percent of your portfolio. Yes, you can profit from Merger Arbitrage, Leveraged Long Short Funds, Currency Arbitrage and a host of other “alternative” strategies, but do you really need to invest in them in the first place? Call me old-fashioned, but the Big Five mentioned earlier have worked well for decades.

Final truth. Hold on. The markets will normalize. Until then, stay rooted in the basic truths of investing and focus on using your gifts and talents to best pursue your calling and career.

Matthew “Matt” Burton is President and Co-founder of Narwhal Capital Management in Atlanta, Georgia, and co-author of Calvin and Commerce. Matt received his bachelor’s degree in business administration from Samford University and, upon completing graduate work at Georgia State, earned the designation of Chartered Financial Analyst. He speaks frequently at investment conferences and to young adults.