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Articles
Market Volatility Shouldn’t Rattle a
Good Financial Plan
On Feb. 27, 2007, the Dow Jones Industrial Average slid 416 points,
the biggest drop since the market reopened after the 9/11 attacks.
By early May 2007, the market had more than made up those losses
and stood at record highs. Other dramatic fluctuations have occurred
in the markets since then...
How did you react? Did you turn off the news? Did you call your
broker in a panic? Or did you call your financial planner professional
to reconfirm that your plan was solid?
It’s easy to succumb to the urge to sell if the market takes
a header or buy after it’s headed upward. But sudden action is
usually a mistake. In the late 1980s, Harvard psychologist Paul
Andreassen made news with a research project that found that people
who listened to market news actually made significantly lower
returns. Why? Because those who sold - or bought - during a market
swing probably found a day later that the market was really running
on hype, not fundamentals.
You pay a financial planner professional to devise a financial
strategy that matches your risk tolerance and long-term financial
goals. No, there is absolutely no way to guarantee that you’ll
never lose money. But if a plan truly matches you, the noise level
on TV shouldn’t make a difference. So the next time the Dow spikes
or slides, ask yourself:
What’s my plan? If you’ve worked with a good financial
planner professional, you should be able to articulate those goals
all by yourself or refer to an investment policy statement you
made together. Much of the riskiest investing, overbuying and
panic selling during the late 1990s and early 2000s could have
been avoided if individual investors had sought advice for achieving
long-term specific goals such as retirement or a college education.
What’s my risk tolerance? At your first meeting with your
planner, you should have discussed - and later filled out - a
form asking you a number of questions about how you handle risk
and what your expectations were about investment returns. You
might have had to do this more than once if your risk tolerance
was low but your investment expectations were high - low-risk
investors can’t expect the highest returns. That’s part of the
education process when you visit a planner.
Am I prepared to stay invested - no matter what? We all
remember the “Tech Wreck” of 2000. At the worst of that downturn,
investors bailed out of the stock market or drastically cut back,
only to get back in after they were “convinced” that the
market was rebounding. In reality, they missed out on large stock
market gains during the early stages of recovery, and that’s costly
in the long run. Of course, some investors looking for that late
20th century investment high also got into the real estate market,
and they perhaps learned a similar lesson when that market started
heading south two years ago.
Ames Planning Associates’ president, Harv Ames, once had the
opportunity to lunch (amongst 20 others!) with the fabled Peter
Lynch, who managed the Fidelity Magellan Fund from May 1977 to
May 1990. When the opportunity presented itself, Ames asked Mr.
Lynch what his greatest frustration had been while managing this
huge... and hugely successful... fund. “Well,” he mused, “it had to
be the individual investor who, although investing just a portion
of their funds with us, for our aggressive growth style, still
believed that they (the investor) somehow could perform better
than us by selectively putting moneys with us when they thought
things were going up (further) and, then, would pull their moneys
after things had gone down in value. We analyzed these in- and
out-flows from such investors and found the following: on average,
those who thought they could ‘market time’ out of and back into
our fund, received returns, compounded annually, of a bit in excess
of 9%. Thus, an investment of $100,000 by them in May, 1977, out,
in, out, in, would have yielded a final value, 13 years later,
of about $310,000. However, during that same 13 years, including
all downs... and subsequent recoveries... within Magellan, the fund’s
return averaged about 28.2% per year. Or, to put it into ‘common’
terms, an investment of $100,000, left alone for those 13 years
could have grown to about $2,500,000. Thus, believing they ‘knew
better’ than us how to do our work, the individual investor sacrificed
about $2,200,000 - or almost 90% of their total potential return.
We never expected anyone to place all their moneys with us... but,
we believed, for those moneys placed with us, had we been allowed
to do what we did best, we would have served those customers very,
very well.” There are many lessons here... not the least of which
is that, when we hire professionals, we need to be wise in who
we choose as our advisor, firm in our self-knowledge as to our
risk tolerances, and steadfast in following our plan for our own
best interest.
In 2004, SEI Investments studied 12 bear markets since World
War II. Investors who either stayed in the market through its
bottom, or were fortunate to enter at the bottom, saw the S&P
500 gain an average of 32.5 percent (not counting dividends) during
the first year of recovery. Investors who missed even just the
first week of recovery saw their gains that first year slide to
24.3 percent. Those who waited three months before getting back
in gained only 14.8 percent.
Am I diversified? The NASDAQ lost 39 percent of its value
just in 2001, and another 21 percent in 2002. Meanwhile, real
estate investment trusts, which performed poorly in 1998 and 1999
when stocks were booming, had banner years in 2000 and 2001, performed
so-so in 2002, and had an excellent 2003. Bonds also returned
well during the bear market. Your planner, based on your risk
profile, should have you in diversified investments that fit your
goals.
Do I still feel the same way I used to about returns?
Having a long-term investment plan doesn’t mean that you simply
make the plan and leave it to gather dust. You and your planner
should decide when it’s time for a review of your investment goals
and your feelings about them. An annual conversation makes sense
if nothing’s going on, but life events like death, divorce, kids
moving out and illness are good reasons to do a head-to-toe review
of a financial plan.
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