Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Thursday, May 27, 2010

Getting Over Market Jitters

If you’re having nightmares about losing all your money in the stock market, you’re probably not alone. It’s understandable too, given the wild volatility we’ve seen since the crash in 2000. The “flash crash” a couple of weeks ago would give anyone pause for concern.

And on top of all that, we’ve had to deal with one of the worst economic crises most of us have ever experienced. And, just as our economy seems to be making a recovery, we have unrest in the European economies. If that wasn’t enough, the volcano in Iceland has been seriously disrupting European air travel; there have been earthquakes around the world and a disastrous oil spill in the Gulf of Mexico that threatens a substantial portion of our economy. And finally, there’s the ever present worry of another terrorist attack. If we weren’t optimists, we’d be totally depressed!

But are things really that different than in the past? A week ago our firm was updating a chart that showed large U.S. stock annual returns versus T-Bill annual returns from 1926 through 2009. One might think that the chart from the year 2000 through 2009 would look much different than from 1926 through 1999. Yet there was little difference. Yes, the return for large U.S. stocks in 2008 was the second worst on the chart, but from a distance, the 2000 through 2009 part of the chart didn’t stand out.

The point is, we’ve had many severe market downturns in those 84 years. And more often than many would expect, the market recovers in a fairly short period of time.

And while there’s much to worry about (including the specter of high interest rates and inflation as a result of the mounting U.S. debt), does it make sense to get out of the market and put all your assets into seemingly safer money markets, CDs and TIPs? If you are a multi millionaire, perhaps you can afford to do that. On the other hand, if you’re a typical investor, you must not forget about the effects of high inflation eroding your purchasing power.

To reiterate, there are two main types of risk you need to worry about: inflation and volatility. Unless you have more money than you know what to do with, if you ignore either, you will have difficulty meeting your long term goals. We wrote an article in October 2008 titled “Risk Has Many Faces” that discusses these issues in more detail. We wrote:
“Losing purchasing power due to inflation can be just as devastating to your
retirement plans as a big market downturn. The difference is that markets
recover while prices continue to rise. Therefore, those of you who avoid
investing in equities could be in substantially more trouble than those who are
aggressively investing in the market.

Many people who avoid investing in the market have been told that they need equities in their portfolio to keep up with inflation, yet they still choose to shun the
market. Why do they do this? We can get some insight from the book
“Your Money and Your Brain” (Simon and Schuster, 2007), by Jason Zweig, a senior
writer for Money Magazine. Mr. Zweig points out that people are extremely
averse to suffering any kind of loss. Worse still, are losses that result
from them taking some specific action, such as buying a stock or mutual
fund. Therefore, they are more comfortable doing nothing (e.g. keeping all
their assets in safe bank accounts and CDs), even though it may result in an
even more disastrous consequence, a substantial reduction in their purchasing
power. They need to realize that by “doing nothing” they are really
avoiding an alternative (i.e. taking an action) that in all likelihood will be
good for them in the long run.”
If you are tempted to pull everything out of the stock market, keep the above points in mind. If you focus only on volatility risk, you will find that the risk of inflation can be just as detrimental to your financial plans. You need a diversified portfolio that includes both fixed income assets and equities. If it’s broadly diversified and you rebalance on a regular basis, you should be able to weather the market storms of the future.


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