Playing 'What If' With Your Investments
PHOTO: Traders work on the floor of the New York Stock Exchange (NYSE) in New York, June 24, 2013.

All too often, people navigate the investment terrain like a driver looking in the rearview mirror. They invest not on the likelihood of what will happen but on the basis of what has happened.

This misguided investment "method" isn't confined to amateurs. Many professionals are equally guilty. But many aren't. While most investors measure risk only in terms of how certain types of events and trends have affected investments in the past, well-funded investment firms are constantly looking forward. Their teams of highly paid economists look at the risk that identifiable scenarios might have on virtually any type of industry or company and the investments in them.

Whether it's increasing economic growth, a terrorist attack, a decline in the price of gold, a change in the majority of one house of Congress, the fiscal cliff or what-have-you, these professionals quantify the likely impact on domestic and foreign stocks, corporate bonds, Treasuries — you name it.

These analysts don't produce rigid projections. Instead, they project a range of likely impacts, from mild to heavy. After all, they're assessing investment risk if certain things happen rather than predicting events and outcomes with certainty. Whether these firms view these impacts as bad or good depends on what side of a particular investment they're on. If they're buying stocks, a heavy hit would be bad. If they're shorting, this impact might be positive for them.

A relatively new, small company is doing something similar, only in simpler terms, producing software that investment managers can integrate into their client portfolios. This product, born after the 2008 market meltdown — when investors who had long ignored risk suddenly couldn't get enough risk management — is Hidden Levers, software that investment managers use to stress-test client portfolios against different degrees of impact of economic trends and specific hypothetical events.

"You don't want to be a doomsayer or Nostradamus," says Raj Udeshi, one of the New York company's founders and a former trader. "Good economic research can indicate the best- and worst-case scenarios — bookends of what might happen. The key is, look at all potential investment outcomes from a given event, trend or development — from the best- to the worst-case scenario."

Hidden Levers is so named because, after its innovative software is interwoven with a graphic representation of an individual's investment portfolio, users click on and slide levers next to each of the various possible scenarios. They can then see potential quantified impacts on each of their investments, ranging from mild to severe.

The product's reception among investment managers has been highly successful, and the product has achieved significant advisor trade-press buzz.

In a departure from the typically stuffy world of market analysis, this is a product with a sense of humor. For example, impacts are categorized as to their severity as "the good, the bad and the ugly," and heavy-loss scenarios as "Thelma and Louise" – a reference to the movie in which Geena Davis' and Susan Sarandon's characters plunge into the Grand Canyon in a Thunderbird convertible. Thus, the software provides relative-scale impacts that are readily identifiable by the average individual.

Yet, with the exceptions of highly engaged, wealthy individuals and well-funded day traders, Hidden Levers isn't a product that individual investors can afford. Prices start at $300 a month and go up to $1,200, depending on the particular version of the service.

However, the product's underlying rationale is instructive for individual investors because of what it demonstrates about how economic developments and current events can affect specific investments. These lessons include:

• You should assess potential outcomes specifically and incrementally. Fear keeps investors from doing this. These emotions can prompt rash behavior. For example, if you were particularly scarred by 9/11, you might be especially fearful that another catastrophic terrorist attack on the U.S. will occur, sending the stock market falling. Though, if this fear intensified, it might prompt you to sell the ranch, a more particularized projection of impacts might mean you'd be more restrained, selling some of your holdings in certain investments and perhaps putting the money into investments that aren't affected.

• Those impelled by greed – and looking to capitalize on what they see as the likelihood of certain events occurring -- shouldn't bet the ranch. Just as portfolio managers can move levers to see a range of impacts, you can do your own analysis of potential impacts, one investment at a time, to identify potential opportunities. This analysis may reveal that, if such events occur or certain economic trends set in, some investments might not be as lucrative as greed alone might suggest.

• Keep your projections specific. While major events can move major indexes, such as the S&P 500 or the Dow Jones Industrial average, unless you own funds pegged directly to these indexes, a drop in one of them doesn't necessary mean a big hit to the stocks you actually own. If Hidden Levers tells us anything, it's that different industries and companies can register vastly different impacts from the same events.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

Ted Schwartz, a certified financial planner, is president and chief investment officer of Capstone Investment Financial Group. He advises individual investors and endowments, and serves as the adviser to CIFG UMA accounts. Because Schwartz has a background in psychology and counseling, he brings insights into personal motivation when advising clients on how to achieve their wealth management goals. Schwartz holds a B.A. from Duke University and an M.A. from Oregon State University. He can be reached at ted@capstoneinvest.com.

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