Letter to Our Clients - July 2013
Dear Clients and Friends,
The Markets in General
We have received several phone calls about “this crazy market.” People are afraid that since the stock market is near record territory, it must be ready to collapse again. People are surprised that their bond holdings have “lost money!” We are hearing the phrase: “I can’t afford to lose again like I did in 2008!”
Please remember this: Your accounts are not like buckets that fill up with water in good times but develop a leak in down markets. Instead, you own assets, a collection of stocks, bonds and other securities. They will fluctuate in value. When you look at your month-end statements and see higher account values, it does not necessarily mean that you “made money.” When your month-end statement shows lower values, it does not mean that you “lost money.” It means that the values “the markets” have placed on your assets are now greater or less than the last time you looked.
Ted and I were at a conference in early July where a speaker used this expression: “As financial advisors, our job is to help clients understand that they cannot avoid financial storms. We CAN help them invest so that they can survive such storms and remain financially stable.”
In order to help you survive and thrive in “crazy markets,” we must identify your short-term, intermediate-term and long-term needs. Funds for shorter-term goals should be invested in securities with lower fluctuation/lower return, or with predicted minimal fluctuation. Funds set aside for long-term needs, such as for retirement income, should be invested to be able to generate cash-flow when needed. For such goals, investing to avoid fluctuation risk will likely be harmful to the long-term objective of having money available as long as you live.
The Stock Market
Our memories grow fuzzy. When have the markets not been “crazy”? Look how much the stock market has come up this year, and in the last 3 and 5 years. If it dropped 10%, it might just bring us back to where things were on New Year’s Day. Would that be so bad? If the market dropped 50%, we might be close to where we were in 2009. That would be disappointing, but it is possible, and yet it would not necessarily mean that your financial goals have been sidetracked.
Let us talk about exactly how much “was lost” in 2007-2009.
When we look back on the stock market high of 2007, it is obvious now (although it was not then) that the market was over-valued. At the end of 1999 and early 2000, stock market values were dramatically over-valued, but it took two years to fully understand that. So the puzzle is that if something is selling for much more than it is worth, and the price drops back to a reasonable value, why do we say it “lost money”?
Most of our clients did not sell their stock market holdings in 2007 – 2009. We are finding that generally those clients now have account values higher than they were in 2007. (If you are curious about how your accounts have done over this time period, be sure to give us a call.) More importantly, those clients who stayed with their investment strategy typically are now much better positioned to meet their financial goals than those who changed their investment strategies to avoid a future which never occurred.
What will happen next? All we know is that the markets will go up and down, we just don’t know when, how much or for how long. Why is that important? We think you need to be invested so that you are on track to meet your investment goals, and not worry about whether you do better or worse than the stock or bond markets. Also, keep in mind that your investment time horizon is likely to be 20 years or more, equal to your actuarial lifespan plus that of your spouse. It is even longer if you anticipate passing wealth on to future generations. What happens over the next month, year or even 3 years does not affect your long-term financial health as much as the decisions you make today about what your long-term financial strategy will be. However, it is also important to remember that a strategy is only effective if it is followed.
The Bond Market
The bond market is basically simple. When interest rates go up, the value of existing bonds goes down. Conversely, when interest rates drop, the value of existing bonds goes up. This is the economic equivalent of the law of gravity.
Since 1982 interest rates have been dropping. Likewise, the values of existing bonds have been going up. That has made many bonds look like great investments, because they have been paying interest rates higher than money market accounts AND they have been increasing in value.
In early May, 2013, interest rates were at record lows. But, interest rates cannot stay at record lows forever. They must go up. They will go up. They did go up! As a result, the values for existing bonds have been dropping since mid-May. This has been predictable, it is inevitable, and it should not be a reason for headlines or panic. It also should not change your stock/bond/cash ratios.
Bonds play two roles in your portfolio. First, they have the potential to generate cash-flow greater than is available in most money market accounts or bank accounts. Second, while bond values do fluctuate, they typically fluctuate much less dramatically than the stock market does.
For example, while bond values might drop 5% to 15%, the stock market can easily drop 20% to 50%. Thus, the role of bonds in your account is to help stabilize your accounts’ portfolio values and to generate cash-flow. This cash-flow can be used for retirement income, or to buy more stock market holdings.
Proactive versus Reactive
We believe more money has been lost (in the true sense of the word) by people thinking they can predict when to get in or out of the market, than has been lost by a “buy-and-manage” philosophy such as we endorse. Headlines and media talking points want to provoke fear and greed, which in turn encourage stock and bond trading. This kind of activity generates income for the financial services world, usually at the expense of the average investor.
We would like to take that income away from Wall Street by helping our clients build and preserve their wealth. We do that by creating an investment strategy that can allow investors to be positioned for potential growth in up markets, but with a bond/cash ratio that manages their financial security in down markets.
As always, please contact us if there is anything you would like to discuss. And, again, thank you for the opportunity to work with you. May your summer be perfect!
Robert K. Haley, JD, CFP®, AIF®
Theodore R. Haley, CFP®, AIF®
*The purchase of bonds is subject to availability and market conditions. Market risk is a consideration if sold or redeemed prior to maturity. Some bonds have call features that may affect income. Past performance is no guarantee of future results.