Your Portfolio’s Honeymoon Phase

Most of us are familiar with the honeymoon phase of a relationship; those first 6 months (or so) when you are positive that you’ve met your handsome prince or your beautiful princess.

Then reality kicks in.

It is only during periods of adversity that you know for sure whether your Dr. Jekyll is really a Mr. (or Mrs.) Hyde. Perhaps when the going got tough for you, they decided to get going. You begin to realize that an emotionally supportive and financially stable prince or princess may have been the better long-term option.

Nonetheless, many decide to get married during this honeymoon phase, ignoring potential red flags and problems that might develop down the road.

I would argue that most investments have been in a rather long 9 year honeymoon phase since the financial crisis. While there have been some bumps in the road, there haven’t been any US stock bear markets during this time. However, bear markets, like relationships gone sour, are a part of life. It is important to understand how your portfolio will fare during a bear market.

Is your portfolio heavy in stocks? Do you have the investment time horizon and the stomach to cope with a large decline in its value? Contrary to conventional wisdom, large stock market declines are only realized in retrospect, not telegraphed in advance. No advisor or market pundit can reliably predict them. This honeymoon phase in stocks has been a great party, but overindulgence in stocks can cause a massive hangover of unexpected losses when the honeymoon ends.

Do you understand and have you researched what you own? If an investment is making money, it is easy to gloss over the details and to not do your homework. What happens to this investment in a bad economy? Can you sell it whenever you want? Is the investment more hype than substance? Not doing your homework to understand your investments is akin to getting married without auditing your partner’s financials. It can work, but you are taking on a tremendous risk with potentially serious long-term consequences.

Does a single investment position or two (stock or otherwise) make up a large portion of your portfolio? Maybe your holdings are “can’t miss” and will power forward indefinitely, taking you all the way to a luxurious retirement. However, as Enron, Worldcom and Lucent have taught us, investments are “can’t miss” until they aren’t. Past performance is no indication of future results and it is always possible for a risky investment to go to zero. Holding very concentrated positions can accentuate returns during a market honeymoon, but they can create catastrophic losses when the honeymoon phase ends.

Your investment portfolio is akin to any long-term relationship. There will always be the fun times when everything seems easy. However, adversity is part of life and this relationship must be able to weather the tougher times. Get to know how your portfolio could behave outside of the market’s honeymoon phase and make sure it is a good fit for you during both the good times and the bad.