Wednesday, February 28, 2007

Vanguard − Putting market volatility in perspective

Vanguard − Putting market volatility in perspective

I'm just going to post the article here so you don't have to link to it:

Putting market volatility in perspective

Tuesday's stock market decline set off loud alarm bells on Wall Street. But even for investors who don't make a habit of daily market-watching, the biggest one-day point loss since 2001 was certainly an attention-grabber.

However, the sharp drop in stock prices was nowhere near a single-day record. The Standard & Poor's 500 Index fell nearly 3.5%, just over 50 points; the Dow Jones Industrial Average fell 416 points, or 3.3%.

"There's no doubt that a big drop in stocks can be tough on your nerves and your account balance," said Gus Sauter, Vanguard's chief investment officer. "But after a day like Tuesday, it's more important than ever to maintain a long-term perspective."

Tuesday's decline put the stock market's return so far in 2007 into negative territory. But over the past 12 months, the broad stock market has still produced a total return—price appreciation plus dividend income—exceeding 10%. That gain, coincidentally, is roughly the long-term average annual return for U.S. stocks.

"We've had a very nice rebound in stocks since the long bear market that began in early 2000 and stretched into 2002," Mr. Sauter said. "So it's not surprising to see a pullback."

Investors who hold balanced portfolios—some bonds or bond funds along with their stock funds—had gains on bonds on Tuesday, offsetting some of the stock market's decline.

As investors digest the volatility of the market and the flood of commentary that always accompanies such events, it may be helpful to reflect that no one can say whether stocks will continue to decline or whether they'll soon rebound. What is clear is that few, if any, investors have a demonstrated ability to consistently pick the right times to get in—or out—of the markets.

"We've long advised investors not to react much to market movements because we don't think it's a successful way to invest," Mr. Sauter said. Indeed, he offered that view less than a year ago—after a downturn in stocks in May 2006—in this interview.

He also offered a bit of advice for "bargain hunters." Although a market decline undoubtedly makes stocks cheaper, he doesn't recommend that investors "buy on the dips." Rather, Vanguard suggests that investors hold to their asset allocation plans.

"The stock market never goes straight up," Mr. Sauter said. "To be a successful investor over the long term, you need to understand this fact and you need to react rationally when the market doesn't go your way.

"Successful investing is a rational, not an emotional, pursuit. If you've made conscious, deliberate decisions based on your personal financial goals, time horizon, and your tolerance for risk, there's no reason to change your plans."

A historical perspective

Two decades ago, in the stock market crash of October 19, 1987, the Dow industrials and S&P 500 plummeted more than 22%, one-day records for both indicators. Those 1987 declines sliced 58 points off the S&P 500, while the Dow industrials fell 508 points. Both declines were from far lower levels than the indicators are in 2007. The S&P began October 19, 1987, at 283, while the Dow began that day at about 2,250.

Scott Dauenhauer, CFP, MSFP, AIF