Money Talks: Price conscious investing
Certainly investors here in paradise are familiar with the concept of price conscious shopping. Everything from household goods to real estate sells at a premium. This is accepted as simply the cost of conducting business while enjoying the beauty of the tropics.
As the stock market toys with record highs as of late, there is always the concern with investors as to the price of both the market indices as well as individual portfolio holdings, and with good reason. For most retired investors, the concept of price conscious investing is mostly left up to professional advisors to build and maintain any given portfolio. A good example would be the use of Mutual Funds as opposed to picking stocks. In this case the concept of pricing is in the hands of the money manager.
What may be lost on many investors is the fact that there is a great deal of technical and fundamental research conducted on each holding in the portfolio. Mutual fund managers and stock pickers alike use various methods to establish a baseline comfort level at which they will consider either buying or selling any given holding. There are many manifestations of price conscious investing. One of the strategies used is what is referred to as a P/E ratio, or price to earnings ratio. This is perhaps the most widely used measurement on Wall Street.
There are certain pricing thresholds used in establishing an acceptable P/E ratio. More conservative portfolio managers will implement a lower P/E ration when choosing which stocks to buy or sell within the portfolio. A lower P/E ratio will filter down to stocks which may be priced lower relative to the ratio, which in theory represents a safer value level inside the portfolio. Now, it is critical here to remember that regardless of PE ratios or any other pricing standards used, when the overall markets correct…or even worse, that an outgoing tide lowers all ships. In other words, PE ratios do not necessarily represent any more safety during weak market conditions, however it may be associated with the concept of perhaps less downside when markets do correct. It may seem irrelevant to many retired investors, but the reality is that most would prefer a 20 percent loss in value over a 40 percent loss.
Yes, obvious yet still relative.
There is also perhaps the most widely recognized measurement of pricing in the form of the daily headlines tracking the daily values of the Dow Jones average or the S&P 500. This is obviously an easier pricing structure for most investors to grasp. There is an entirely separate school of thought for many retired investors who simply look at the markets run up in value combined with the length of the recent market run, recent as in the last 8 years, and make the assertion that the markets simply feel too overpriced. Often this is simply a person al decision based on empirical knowledge, or knowledge through experience. With current market conditions, we are essentially in uncharted waters.
Another pricing conscious decision many money managers must make is with regards to the buying and selling of bonds within the portfolio. There are several variables used in this process, however the most basic is maturity versus value. The longer the maturity of any debt instrument, the higher the yield. Thirty year bonds generally pay more than twenty year bonds. The trade off here that must be considered by the money manager is that if and when rates begin to rise, the value of bonds drop. Specifically, longer maturity bonds will suffer greater loss than the short term bonds. Just imagine a see saw on the children’s playground. The far ends of the plane move far more in both directions than close to the middle. Yes, price conscious indeed.
Finally, in an effort to maintain pricing perspective, it is important to separate the reality that pricing is a non-issue for insured index investing strategies with their ability to avoid market losses. Also, the ability of managed futures to avoid market correlation often offers investors the ability to forget about the need to be price conscious and enjoy the life of a SWAN, Sleep Well At Night.
William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.