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Invest Like Goldilocks

| January 20, 2016
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Investment Management, Diversification, Retirement Savings

Most of us are familiar with the fairy tale, “Goldilocks and the Three Bears”.  But, in case you’ve forgotten, the story is about Goldilocks- the little girl who came upon a dainty little cabin in the forest and decided to go inside.  Making herself at home, she taste tested three bowls of porridge left on the table.  One was decidedly too hot, another too cold but the third was just right.  After finishing the porridge, she decided to test the furniture trying out their chairs and beds, each time finding the perfect fit.  After some time, the owners of the cabin (3 bears) returned home from their walk.  Momma bear, papa bear and baby bear quickly discovered that someone had been eating their porridge, sitting in their chairs and ultimately they discovered the culprit sleeping in their bed.  Of course, the story ends with Goldilocks safely escaping the cabin in the woods never to return again. 

What investment lessons can we possibly learn from Goldilocks and the three bears?  While it might be a stretch, please let me introduce a re-write to the story to offer an education of how we might learn from dear Goldilocks how we too can safely get away from the bears in our investment decisions.

Once upon a time (in late 1982) there lived a young woman named Goldilocks who was concerned for her future and felt lost in the information world where she found herself.  She was frightened about the uncertain future and understood that her family health history of longevity coupled with rising costs in the world meant she would need to find a way to grow her money to ensure that its ability pay for her humble lifestyle would be maintained for many years after she stopped working.  It was at about this time that she fearlessly entered the investment markets through her retirement savings plan. 

First considering stocks, she experimented for a short while placing all of her money in stocks.  “Ouch”, she exclaimed when in late 1983 and into 1984 she lost about 14% of her money during a stock market correction.  Goldilocks felt that being invested 100% in stocks made her portfolio too hot so she decided to try bonds instead.  Unfortunately, bonds were too cold and unsatisfactory for her liking as she desired to outpace inflation by a greater factor.  It was then that she decided that a measure of each could provide her with balance and it was just right. 

Another discovery, Goldilocks made while investing in the markets was that she should not be entirely weighted in large-cap stocks and long-term bonds.  This discovery came after an interest-rate increase where she saw the value of her bond portfolio went down.  Being impulsive, Goldilocks moved her portfolio entirely to small-cap stocks and short-duration bonds.  Here again, this was not to her liking.  The stocks in this portfolio were way too volatile and the short-term bonds weren’t providing enough income to counteract the negative returns of the stocks.  What was she to do?  Goldilocks again found the best fit in a comfortable blend of large-cap, mid-cap, and high-opportunity small-cap stocks and an equally well blended bond portfolio of short, intermediate-term and long-term bonds.  Things were good for Goldilocks and she found herself so comfortable with the all-weather blend portfolio, that she was able to sleep easy at night comforted by the various solutions she had discovered.  After falling comfortably asleep with her all-weather portfolio, the bears returned- that is the bear markets[i].  First, came Baby Bear in 1987- a four month stock market drop of 24%[ii].  Mamma Bear came in the year 2000, staying around for 30-months causing the stock market to drop by 43%ii.  Ultimately, Pappa Bear arrived in late 2007 and stayed for 16-months taking the stock market down by 51%ii!  Through all three bear markets, Goldilocks was scared but did not sway from her all-weather investments.  Her portfolio experienced some turmoil during those years but holding to her well-diversified, balanced strategy, it ultimately recovered and then some.  After some time had passed, Goldilocks retired comfortably buying her dream cabin in the woods and lived happily ever after. 

The cabin represents capital markets, a place foreign to most of us and Goldilocks was no exception.  While in the home of the Pappa Bear (2007-2009), Mamma Bear (2000-2002) and Baby Bear (1987) she finds the perfect temperature porridge (think stock:bond ratio), right size chair (think stock market capitalization and/or bond duration) and the most comfortable bed (or, sleep-easy allocation).  

Daniel Grote, CFP® is a Partner with Latitude Financial Group, LLC a comprehensive financial planning and wealth management firm located in Denver, Colorado serving clients across the nation. | 720-881-8741

[i] According to a Bear Market is defined as, “A market experiencing an extended period of declining prices.  A bear market is the opposite of a bull market”.

[ii] Source: First Trust Advisors L.P., Morningstar. Returns from 1926 – 5/31/14.              

The above is a hypothetical example provided for illustrative purposes only.

Diversification seeks to reduce the volatility of a portfolio by investing in a variety of asset classes. Neither asset allocation nor diversification guarantee against market loss or greater or more consistent returns.

Investment involves risks. Stock and bond values fluctuate in price so that the value of an investment can go down depending on market conditions. Stock prices may fluctuate due to stock market volatility and market cycles, as well as circumstances specific to a company. The two main risks related to bond investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Bonds are considered fixed income securities and if sold or redeemed prior to maturity may be subject to a additional gain or loss.

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