What I Am Doing With My Mom’s Money

How many times have I heard the word “unprecedented” this week? Too many for sense. The financial market movements are unprecedented, the steps the government is taking are unprecedented, the uncertainty of corporate health is unprecedented, and so on. As someone entrusted with the net worth of many families, I take the events of the last week very seriously. But the inaccurate use of the term unprecedented may be the most unprecedented phenomenon of the week.

What was not unprecedented

• It was not unprecedented that the stock market had a double digit decline in the middle of a week.
• It was not unprecedented that in a crisis a single sector of the U.S. economy (the financial sector) had a major impact on companies outside the sector.
• It was not unprecedented that the U.S. government stepped in to take over or guarantee the solvency of a major company (or let another one fail).
• It was not unprecedented that a big-name, 100-plus-year-old company went out of business.

What was unprecedented

• What I believe was unprecedented was the amount of money pledged by government to prop up companies and the number of levers pulled to stem the crisis.

The key to the week’s volatility

I wrote to you last month, in my article Taking Measure, that bank credit is one of the five keys to an upturn in the economy and the financial markets, but one that is not now a positive. Sure enough, bank credit is the primary theme of this week’s crisis. The ongoing crisis in the financial sector of our economy has a direct impact on other sectors because banks can’t or won’t lend the money companies need to manage or grow their business. Even some companies that don’t need to borrow have been affected— many by customers’ worries. And this is important to note: some unfounded worry and frenzy from the stock-market market drop is fostering unfounded predictions of general doom.

I don’t want to use this article to explain why Fannie Mae was too big to fail, or how the sale of credit default swaps did in Lehman Brothers, or why AIG had to secure a $14.9-billion bridge loan from the U.S. government. I don’t know whether you care, or should. But you do and should care about the exposure of your hard-earned money to failing companies and whether the financial markets in general are headed down for so long that you might never see your assets’ former value return.

Calculating losses, gaining perspective

If you are a client of mine your exposure to AIG might be in a fund¹ that, in total, represents 8% of your portfolio. AIG represented 2% of that fund’s portfolio. So AIG was 0.16% of your portfolio. Your exposure to Lehman Brothers might have been in a fund² typically representing 8-12% of your portfolio, where Lehman was 0.29% of the fund’s portfolio. I don’t need to calculate the miniscule percentage that Lehman represents in your portfolio to make the point. Experience has taught me that the event-risk of being invested in just one part of the market is not worth it; so that’s why you are well diversified.

Mom’s Money

Let me also repeat the formula I’ve stuck with to allocate your assets and stay away from dramatic bets: If you need the money in the next 12 months, it is in a cash equivalent; if you need it in the next 3-4 years, it’s mainly in bonds; and if the plan is not to use it for at least 5 years, it’s mainly in equities.

The markets are sure wild right now. But 4 years from now you won’t be able to say whether the middle of September 2008 was an up or down week for your portfolio. So what am I doing with my mom’s money? The same thing I’m doing with yours. This strategy works. It gives my family stability in the short run and lets us ride out market volatility in the long term.

And Mom, when you read this know that you’re okay.

¹Davis New York Venture (nyvtx); holdings as of June 30, 2008

²Thornburg Investment Income Builder (tibax); holdings as of June 30, 2008