Posted: August 17, 2007
WEST COVINA, CA – When Thomas Paine wrote those words in his pamphlet “The Crisis”, I am pretty sure he did not have the current gyrations of the stock market in mind. Yet this quote pretty much sums up the feeling of many investment professionals who have seen several occurrences of this nature in the past.
Was it really only a month ago when the S & P 500 hit an all-time high of 1555(3)? Since then it has fallen by almost 10% from that peak as of yesterday’s market close. The question is, is that it or is worse still to come?
Well, I am not in the business of predicting the day-to-day fluctuations of the market. Indeed, nobody can do that or at least nobody can do that with any level of consistency or certainty. In my formative years as a financial professional, oh – about 10 or so years ago, I was called to do that. There was always something I could point to in conjuring a reason for why the markets did this or did that on any particular day. I could also conjure up a prognostication for what the markets would do for the following day or the following week and support such a view with seemingly compelling justifications. Predictably, nobody would call me out on how those predictions would eventually turn out. You see, predicting short-term market direction has a short “news cycle”. The following day or as in many cases, the following hour, the markets would do something and someone else would come out with their own opinions on what the markets would do and why the markets would do that. Again, nobody would call out this analyst on these prognostications. That was my previous life and I have since grown up.
See, in our current reality of shortening news cycles, 24/7 media coverage and the world of blogosphere, we are bombarded by all this “noise” which tends to sensationalize and exaggerate events like these as if these had never happened before. In short, our memories have become shorter.
It would be okay if it stopped here but it doesn’t. The absence of context under which all this “noise” is provided, in many cases, leads to real decisions by typical investors, which we can characterize as “panic”.
It is this phenomenon that can lead to real damage to one’s financial plan. The decisions that are made under this scenario are similar to decisions made in panic mode in the other facets of our daily lives. These decisions tend to be irrational, not well thought and reasoned. Panicked.
As I continue this note, let me begin with these words of caution – past performance may not be indicative of future results.
Having said that let me try to provide some context to the “noise” that we all hear, all the time.
Markets go up, markets go down. More importantly, nobody can consistently predict the short-term movements of the markets.
Given that fact, let me reiterate some of the points of discussions that we have had.
Investing for retirement is a long-term proposition. Thus, short-term market performance should not be an overriding consideration in investment decisions. Many have the erroneous assumption that the time horizon for managing retirement assets stops when we retire. What’s left out is the reality that we will spend 20 or even more years in retirement. Even in retirement, we have to make sure that your retirement assets continue to be managed with the appropriate perspective to avoid the greater danger of running out of money while in retirement.
Diversification is key to managing risk. We have discussed the appropriate portfolio mix for your retirement assets. The construction of your portfolio incorporated diversification among various investment options to provide some level of protection to market fluctuations.
Rebalancing your portfolio should be done in a regular and consistent manner. Because different investments perform differently in different times, rebalancing your portfolio is essential to make sure that you are not overly invested in any particular investment. Another way of putting it would be that rebalancing ensures that you maintain the appropriate level of risk in your portfolio(4).
These are some of the keys to a successful retirement savings plan.
Let me end this note by citing one statistic. A study published by Dalbar(1) estimates that in the 20 years ended December 31, 2005, the average stock fund investor achieved a total return of only 3.9% per annum(2). The return of the average stock fund for the same period, on the other hand, was 11.3%(2).
The reason for the discrepancy according to the study – “unhealthy investor behavior”.(2)
The bottom line is this – the markets will do what they do, it is what individuals do in reaction to the market that determines the success (or failure) of their retirement savings portfolio.
Stay the course and continue to invest in line with your objectives.
(1) DALBAR develops standards for, and provides research, ratings, and rankings of intangible factors to the mutual fund, broker/dealer, discount brokerage, life insurance, and banking industries. They include investor behavior, customer satisfaction, service quality, communications, Internet services, and financial professional ratings.
(2) Source: Quantitative Analysis of Investor Behavior by Dalbar, Inc. (2006) and Lipper. Dalbar computed the “average stock fund investor” return by using industry cash flow reports from the Investment Company Institute and the S&P 500® Index. The “average stock fund” return represents the Lipper Fund Equity Lana Universe. Past performance is not a guarantee of future results.
(3) Source: CNBC.com
(4) Neither diversification nor rebalancing can ensure a profit or protect against a loss.