Tuesday, January 22, 2008

Earning Those Returns...Not Easy, But Worth It

If you turn on the news, open up a paper, or click on a financial website it seems the word of the day is "panic" - heck, now its even on my blog. The media has managed to brew up a storm where none existed and in the vein of "if it bleads it leads" is preying on your fear to keep the markets in the news and in decline. What the media rarely gives you during these turbulent market times is perspective. I'd like to give you some perspective and hope that you'll trust me enough to see that the latest drop in market is completely normal.

First, stocks must go down in value every so often, if they don't they would have no risk and thus no excess return above risk-free assets (like Treasury Bills). Risk and return are related and the price for receiving higher returns in stocks is earned by riding out the inevitable ups and downs the markets will go through. This might sound corny, perhaps even self serving - but you want the markets do what they are doing right now, it weeds out the people who shouldn't own stocks and returns those stocks to there rightful owners - the long term investors, not the short term speculators.

I've included a chart below to demonstrate one thing - it is ABSOLUTELY NORMAL and HEALTHY for stocks to go down in value. When they do go down, they eventually go back up and they go higher than they were before they dropped. What follows is the eleven bear markets the U.S. went through from the end of World War II till the end of the century. In a period of about fifty years we had eleven bear markets, which is defined as a drop of 20% from the high of the S & P 500. This means that on average we have a 20% drop in the stock market every five years. Our latest was during the 2000-2002 tech bubble.

My point is simply that panicking is not the right reaction, though it is the perfectly normal reaction. Most people invest on emotion and watching their money slowly wither away can create extreme anxiety. This is why we need to be well diversified and not have all of our money in stocks.

I think what is important to remember is that this morning 95% of people who wanted to work got out of bed and went to work. Even if we do go into recession, more than likely at least 90% of all people who want to work will wake up every morning and go to work. The world will not stop spinning just because somebody on wall street has hit the panic button.

I cannot and will not predict the direction of the markets. They go up and they go down, sometimes a lot. What I will say is that owning stocks is your best bet to achieving a higher rate of return and beating inflation in the long run. This volatility will soon pass and we will be on our way back to record highs. I don't know when, but I do know that if you panic and sell out you will never see those highs, the only way to participate in the new highs the market is sure to make is to stay invested and stay diversified.

Please call me with any questions. I can't guarantee I'll answer the phone right now, but I'll listen to your message and get right back to you (losing quite a bit of sleep with the new baby!).

Keep your head up and stop watching the news shows, go about your daily life, the world is not coming to an end.

Warm regards,

Scott Dauenhauer, CFP, MSFP, AIF