| I have an idea for combining the two newest trends on
television: the fascination with the stock market and "reality-based"
programming. We could put 16 people on an isolated island (Manhattan will suffice), divide
them into two tribes (called investment clubs), and see which individual can best survive
this year's volatile market. We'd create team-building competitions for the two groups,
such as predicting when the Nasdaq will change its name to Nasdaq.com and guessing the
weight of Alan Greenspan's briefcase. All right, so
my dream of being a network executive will have to wait — back to my day job. But my
idea for the next craze in "reality" TV is related to this week's question.
Do you have any suggestions that might help investors
survive the latest wild movements in stock prices?
Actually, I have three suggestions. And since this is the
month of weddings, I'll frame them as something borrowed, something old, and something
new. I'll let our graphics department come up with something blue.
Suggestion No. 1: Something Borrowed
Save more, and invest more (borrowed from "Basic
Budgeting 101"). Look, I wish I could tell you precisely how much the markets might
earn over the next few years. Actually, that's not precisely true; I wish I knew myself
what the markets would earn, not tell you, make a boat load of money, buy a television
network, and create my new show. But, alas, I'm not that smart. The one thing I do know
is, regardless of the returns in the market, the more you invest, the more you will have.
If Melissa and Ryan choose precisely identical allocations
to securities and funds, and Melissa invests five percent more than Ryan, then Melissa
will have five percent more in her nest egg than Ryan, no matter what the returns are on
those investments. Yeah, it's simplistic, but as is the case with weddings, the simpler
the better (do you hear that, daughter of mine?).
Suggestion No. 2: Something Old
Practice investing discipline. Did you think you were going
to get through a column of mine without hearing about the dangers of that old investing
demon, market timing? Pick an asset allocation with which you are comfortable, and stick
with it throughout all market fluctuations. There are many examples of investors getting
burned by panicking and selling after a market dip, whether the dip is short,
intermediate, or long term.
Here are some illustrations of what I mean. In the month of
August 1998, stock prices fell 14 percent and many investors cashed in their equity funds.
But over the next four months, stocks went up by 29 percent.
In 1987, stocks fell by 32 percent between Labor Day and
Thanksgiving (including the infamous 20 percent decline on October 19), and many investors
panicked. Since then, stocks have earned an average annual return of 20 percent.
And in the most severe downturn that I can personally
remember, the stock market fell by 43 percent between January 1973 and September 1974.
Disheartened by such a large loss, many investors left the market for good. Of course, in
the quarter-century since that time, stocks have increased in value 58 times over! (This
translates to an annual return of 17.6 percent per year.)
So we learn the same investing lesson over and over: pick
an allocation you can live with through thick and thin (particularly through thin), and
maintain that allocation even in down market cycles.
Suggestion No. 3: Something New
Have realistic expectations. This is new only in the sense
that I saw a truly frightening statistic just a few days ago. According to the magazine Pensions
& Investments, (you thought I only read People?) 71 percent of investors in
401(k) plans believe they will earn a return of 20 percent or more over the next five
years. Please go back and read the preceding sentence, slowly. Now of course, the annual
return between 1995 and 1999 was 29 percent, but this has been the highest five-year
return in the history of the U.S. stock market.
If we look at how likely it is to earn a return of more
than 20 percent on stocks, we can see that this expectation is not very realistic.
Between 1926 and 1995, only four times did the stock market
earn a five-year return of over 20 percent:
- Mid-1930s (after the 1929 market crash)
- Early 1940s (thanks to a war-based industrial boom)
- Early 1950s (caused by post-war industrial innovation)
- Mid-1980s (after a relatively severe recession)
Now on the other hand, there have been also four occasions
during the same time period when stocks either earned less than one percent per year or
lost money:
- Early 1930s (caused by the depression)
- Late 1930s (following the mini-market boom of the mid-1930s)
- Late 1960s (triggered by a rise in inflation)
- Mid-1970s (caused by inflation and a recession)
My point? The chances of your investment returning
virtually nothing are as high as your chances of earning 20 percent. Yet, 71 percent of
you have 20 percent earnings expectations. Hey, I'm all for optimism, but more than seven
out of 10 of you are being completely unrealistic. And it's not just me that says so. I
know of no professional advisor who is willing to go on record projecting a return of more
than 12 percent for the next five years.
So to survive the volatile markets, remember: something
borrowed, something old, and perhaps most importantly — your key to survival in the
current investing environment is something new — realistic expectations.
 Lummer's Logic Archives
|
