The first half of 2007 has now come and gone. The stock market was up, down, and up again. In July the “down” part continued the cycle. In summary, 2007 is “normal,” that is, we do not really know why it has done what it has done, or what it will do next.
What we have seen is three and five year gains. We have now gone a historically long time without the stock market dropping 10% or more. A 10% drop from this point would bring the Dow Jones to about 12,000 and the S&P to about 1350. Quite frankly, I think a 20% drop is very likely at some point over the next 3 years. Putting it another way, I think the Dow could easily fall below 11,000 again, and I think the S&P could drop below 1200. Keep in mind that all indices are unmanaged and are not available for direct investment by the public. Past performance is not indicative of future results.
It is easy to have opinions but impossible to predict the future. Even though I believe we all should be prepared for at least a 20% drop in the stock market, I also believe that our best hope to outpace inflation and taxes is to remain invested in equities. The trick is to decide what the mixture of stocks to bonds to money market should be.
It is not practical to say: “Once the market starts to drop let’s decide when it is time to get out.” It is impossible to tell with daily/weekly/monthly declines whether the fall will continue indefinitely, or whether it will stop and the markets will stay flat for an extended period, or whether it is time for a turnaround with dramatic upside gains. Likewise, should there be another cataclysmic event like 9/11, it would likely be too late to protect against a significant loss as the markets can move so very rapidly.
If you are concerned about your account values going down, please contact us soon. In my opinion it could be prudent to take steps now to protect the gains we have made in recent years, and/or to re-position your account(s) now for less fluctuation. The simplest way to do these things is to reduce stock market exposure.
On the other hand, for any investor with at least a 5-year time horizon, I feel there is more risk in being totally out of stocks than there is to be significantly invested in them. Remember, the key to your financial success is long-term performance. The biggest risk to your financial health is not fluctuation in your account values. Your greatest financial risk is that your money may be all gone before you are. Only in unusual cases will I recommend that your stock market positions represent less than 60% of your total investment program. It may be appropriate for you to be 80%, 90%, or even 100% invested in the stock market. It all depends on how you want to manage your risk/reward ratios.
One last thought for this letter. There is a temptation to look at your investment returns and wish they were better. I would like that as well, but I do not think my job is to maximize your investment returns. This would expose you to unacceptable risk of loss in rapidly changing markets. Instead, I believe my job as an investment advisor is to “optimize” your returns, so that you can balance potential growth against possible risk. Thus, I invite you to look at your investment returns, and think about how well you are doing compared to the “average” investor.
Over the years, studies which examine investor results (actual returns of individuals) versus investment results (returns of indexes or the securities themselves) consistently find that investors earn 50% to 90% less than the investment returns available to them. This is due to the fact that many investors fail to develop or stick with an investment strategy, causing them to make emotional decisions based on their perceptions of market trends. This emotional method of investing is very easy to slip into, but it very rarely yields positive outcomes. So, when you look at your returns, I think you should be very proud that you have obtained positive results. I believe this occurred because we have stayed with our long-term investment strategy, making only minor adjustments along the way.
Finally, we always strive to deliver the best possible service and results. However, we cannot know whether we are meeting your expectations unless you tell us. If you would like to receive our survey questionnaire, please contact us to obtain it by mail or email it to you.
Thank you again for the opportunity to work with you. Enjoy the Summer!
Robert K. Haley, JD, CFP®, AIF®