4th Quarter 2009
Most everyone is happy with their returns this year. The S&P 500, which represents the broad blue-chip, the U.S. stock market posted a gain of 23 percent. Even bonds posted a healthy gain of 6 percent. The only sad people I know were the ones that were scared out of the markets and invested their money safely in cash and Certificates of Deposits.
What were the lessons that 2008 and 2009 taught us that we can carry into the future?
1. Your best bet in achieving your long-term goals is to develop an investment strategy that is projected to meet your long-term goals, and then stick with it regardless of how scary things get. Make a financial plan that will meet your needs and goals, and then get tough as nails.
2. It’s OK if you are not a dare-devil and desire some safety in your portfolio. However, it is best to know your limits (and build your portfolio strategy accordingly) prior to catastrophic events occurring. Making adjustments under a mindset of panic is rarely a wise maneuver. For example; if you are 100 percent in stocks and the market declines 40 percent, and then you shift to bonds, it is going to take a very long time at 4 percent to make your money back. Investors who held their positions in 2008 and 2009 have already earned a great portion of their losses back.
3. Trying to time the market is a grand thought, but in reality is a sucker’s game. Do you think it’s the time to get out while the market is high? You have to make two correct decisions to be successful. You have to correctly get out toward the top, but then you also have to correctly get back in when the market is lower. The problem is that most people use emotions in making their decisions. If the market does turn lower the world looks even scarier, thus preventing you from wanting to get back in. Most individuals trying to time the market sell well before the market highs. I know a few individuals who pulled the plug when the Dow was approaching 9000. Now it is at 10,500 or 17 percent higher. I also know a few individuals who correctly got out of the market a year back when the market was around 8,500. They were feeling pretty smart as the Dow continued to drop to 6,600; unfortunately they also felt the market was going to 6,000 and below and never got back in. Regrettably they are still sitting in cash and bonds with the Dow at 10,500 (59 percent recovery).
4. A broken clock is right at least twice a day. Did anyone guess that the market would decline in 2008? Sure, there were a rare few, but they also had made similar calls over and over again and missed out on some healthy profits. I have talked to (and read newsletters from) some of the best investment minds around, this past year. No one has profited consistently from market declines. Here’s another way to think about it; Ever talk to someone returning from Las Vegas? I have talked to hundreds over the years. They all bring back reports of winning. I’m sure occasionally someone comes back with cash, but they can only remember winning and they conveniently forget about all the times they lost money. We like to think we can game the system and hit a home run. In reality, winners tend to bunt a lot and hit a lot of singles.
5. You have to decide if you are going to make your retirement decisions (which is a 30 year plus decision) based on the last ten years of performance or the last seventy years. My economic models are based on data going back to the depression years. This includes some tough times such as World Wars, oil embargos, terrorist attacks, major recessions, etc. I was recently reading about the mindset during the Cuban Missile crisis. People were literally looking out their windows expecting destruction at any moment. Times are not tougher now, it just seems that way. Life is never easy.
The value I bring to my clients is not that I know whether the market is going to go up or down. I help them make healthy long-term decisions based on the lessons of the past and a reasonable outlook of what the future may bring. In short, I help you avoid the mistakes that can destroy your portfolio. Did you know that the historical returns of the stock market are a little over 10 percent per year, but that the average investor has only pocketed a return of around 4 ½ percent? Why? Because when everything is going great they get greedy and when times are tough they get scared.
Here are some thoughts for 2010 and beyond;
1. The truth is that stocks will make more money than bonds, but they are riskier. Stocks go down in value one in every five years. You are compensated for your risk. The long-term compounded rate of return has historically been two and a half times that of quality corporate bonds after inflation is factored in. Since World War II, equity prices have declined an average of 33 percent on thirteen different occasions. Today the market is sixty times higher than it was prior to the first of these declines.
2. The truth is that bonds are safer, but rarely pay much more than the inflation rate. However, when interest rates go up the value of the bonds go down. This decrease in value is offset by the interest payments you receive. Logical people use bonds in their portfolios to lower the risk to the point where they won’t sell out of their stocks when times get tough. Logical people also use bonds during retirement to provide a worry free income, especially when they have saved enough money that it doesn’t matter if they earn more than 4 percent (less inflation).
3. The simple truth is, if you are early in your retirement or you have not saved enough money to live on a portfolio that earns 4 percent (minus inflation), then you need stocks to help you out.
4. I am not pleased with our Government’s spending, but it seems as if there is no stopping them. We have become an entitlement nation, and the most votes go to the politician promising the most welfare to the greatest number of people. The increasing government debt will bring:
a. Lower U.S. economic growth
b. Higher inflation
c. Increasing government regulations
d. A reduced prominence of the U.S. in world affairs. We will not decline to the point of a third world country, but life will be more challenging going forward.
5. My belief is that the way to deal with these new realities is to invest a significant portion of your portfolio into assets that do well during times of inflation. These would include commodities, real estate, infrastructure assets (think utility companies, roads, power lines, water, timber, etc.), and inflation indexed bonds. In order to make room for these new investments, I have decreased the amount of U.S. stocks I recommend. Incidentally, I have also increased the amount of international stocks recommended.
6. There are numerous things that seem wrong with the world and might dampen your investment outlook. These things don’t scare me to the extent these events are already on the front page of the paper, because we have already factored their impact into the market price of stocks. It’s the new unknown events that occasionally hurt us, but even these are priced into the premium that stocks pay over bonds.
Sincerely,
Ron Dickinson, CPA, CFP®, MPA-tax