Fear Runs Rampant

This isn’t a good way to start the year. The typical stock market pattern is a positive market in January. You may have heard of the January effect where stocks start rising in the middle of December (called a Santa Claus Rally) and continue through January. The year 2008, so far, has been dramatically different, and shows why market timers get burned sooner or later.

Right now fear and emotions are overriding all logic and when this occurs, the market swings beyond reasonableness. Long term investors need to be patient and not sell while the chips are down. That’s a sure fire way to lose money. It is easy for the average person to think this way: “If the stock market has been this bad in a few short weeks and a recession is coming how much worse is it going to get?”

One thing to remember is that the stock market is a forward looking machine. Once it anticipates an event, like a recession, it quickly moves to adjust prices. In other words, the prices of stocks today have already anticipated a majority of the potential bad news. I’m not saying we are exactly at a bottom because part of the adjustment is an educated guess by very smart people that deal in the markets full time. As more information is revealed, investors will compare the real news with what they anticipated and make further tune-up adjustments. But rest assured the market pros have already built in some pretty ugly news into the price of stocks. Typically, a market correction is around 15%. This doesn’t mean you are going to lose 15%. Stocks will temporarily drop and hopefully regain some of this amount before the end of the year.

In my year end newsletter, I wrote “The fear of a recession is actually worse than the actual recession”. It would be nice to be able to foresee when the stock market is going to anticipate a recession, but just like this is a difficult sentence to write, it is even more difficult to jump out just in time. It’s a nice theory, but nobody in history has consistently been able to pull this off.

It is also human emotion to conclude that a negative trend will continue. For example, if the market has dropped 10% in two weeks then in another eight weeks it will be down 50%. This is faulty thinking; don’t let your emotions run wild.

As your advisors, we have been through these kinds of markets before. It’s tough to remain focused, but prudent investors have a game plan for their investment portfolio and a retirement strategy. Part of that strategy anticipates that one out of four years the stock market will lose money. The wild ride you experience as a stock market investor is paid back over and over as stocks, on average, have earned double digit returns vs. single digit returns earned by bonds and cash. Please read chapter 3 in my book, which explains that you won’t get ahead by trying to play it safe.

In my recent seminar on “18 Common Sense Rules for a Successful Retirement”, I compared stock market volatility to fire. If you don’t utilize fire you will eat raw food, if you don’t respect fire you will burn your fingers but if you learn to control fire you can enjoy a nice gourmet meal. That’s what I want for you; a retirement full of gourmet meals.

The three key elements of controlling stock market risk are 1) understanding the benefit of time. There will be periods of time where loses occur, but over 5 years the market typically delivers positive returns; 2) diversifying your portfolio; and 3) using the best investments available.

With this in mind, I’m sending this quick letter to remind you of some important concepts:

1. We take market and economic volatility very seriously, but we don’t allow emotions to dictate our strategies. This is just as true when the market is flying high as it is when we see sudden sell-offs.
2. Personal goals do not usually change with the whims of the market. We have established a logical long-term plan that takes into account short-term uncertainty.
3. It is your money. We don’t treat our clients’ portfolios like they are stock market statistics. Your investments require our careful attention.
4. Lousy markets can affect the way you feel about risk. In our review meetings, we regularly discuss risk. We know that in times like these, your comfort level can change.
5. There is nothing wrong with a little hand-holding. That’s why we will be contacting many of you soon. As your financial advisor, we know you may have specific questions about your investments. If you need to talk sooner, please call us.

So, what am I personally doing during these difficult times?

1. I am a buy and hold investor. Even though I don’t like the decrease in my account value, I am keeping my eye on my long term game plan. Part of my plan is to invest every month. When the market goes down, I am buying stocks at a discount from yesterday’s prices.
2. I am reviewing the investments I currently hold for quality. If I make any adjustments, I will also recommend the same adjustments for you.
3. I am looking at buying more investments with any additional funds I have.
a. Berkshire Hathaway has also taken a 15% drop recently and is normally a good stock to buy on pullbacks.
b. High dividend stocks/funds. Several stocks in the financial sector now yield more than CD rates. I can make more money then I make at the bank, plus I will eventually pocket some capital gains.

Please try to ignore the headline news. Often the talking heads are grasping at straws to sensationalize common events. Please rest assured that we are working hard on your behalf.

Ron Dickinson, CPA, CFP®, MPA-Tax