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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.

Sunday, July 11, 2010

Don’t Miss the Party

The last couple of years have been frightening for most investors. Just a year ago last March, the Dow Jones Industrial Average (DOW) was down below 6,500. Last Friday it closed at 10,198. Often, of late, the DOW rises 100 points and then retreats 100 points. It goes above 10,000, then back under 10,000. It has traded in a very narrow range.

Worries about the unemployment rate, rising national debt and a host of other issues have many worried about a double-dip recession. It appears that all the uncertainty and lack of confidence has driven many to either pull out of the market entirely or trim back their equity holdings significantly. It is certainly understandable. But is it really the thing to do?

History has shown that there are relatively few days when the markets make major upswings. Being out of the market on those select days can be disastrous to your portfolio. We write time and time again about trying to time the market. It’s very difficult to do. You must know when to get in and when to get out. Being right once is tough. Being right twice is very tough to do.

Chances are you were in the market when the “Great Recession” market crash happened. You probably are saying to yourself: “If I get back in the market now and there’s a double-dip, I’ll be hurt even more”. You need to ask yourself this question: “Are you so afraid that you’ll never get back in the market?” Most people would probably answer no to that question. They just want to wait until they feel more “comfortable” about the economy, the market, etc. So when will that time occur? Probably after a huge market rally that leaves those on the sidelines lamenting about why they didn’t re-invest earlier.

Unless you have no confidence that our economy will ever recover, we bet you will eventually re-invest what you have pulled out. Poor money market, savings account and certificate of deposit (CD) returns coupled with future higher inflation will drive you to seek higher returns. Unless you get in the market and stay in it through thick and thin, you’ll miss the party.

You’re probably thinking: “Well if the market does have a huge rally, it will probably be followed by another huge crash. So where will that leave me?” We believe in having a target portfolio that is broadly diversified with target allocations for each asset class. Periodically (at least annually) we recommend that our clients rebalance their portfolios, selling asset classes over-allocated and buying asset classes under-allocated. If you rebalance reasonably soon after the “party”, you will trim your equities back and boost up your cash and short-term bond allocations. This should help position you for the next “crash”, after which another rebalance would call for buying more equities.

Another obvious question is: “When might this party take place?” We don’t know but it seems likely it may be a big affair. An article in the July 12 –July 18, 2010 issue of Bloomberg Businessweek titled “When Cash Takes a Vacation” by Roben Farzad, reported that “American Households are sitting on nearly $8 trillion in cash – money that’s earning virtually no return because people are so wary of additional losses.” The article also reports that non-financial U.S. corporations had $1.4 trillion of cash on hand in the 1st quarter of this year. That was a 27% increase over 2007. At some point, the low returns this cash is receiving will motivate corporations and individuals to deploy it elsewhere.

Our guess is the party will likely be a surprise. You won’t get a written invitation. But you are invited.


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