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Learning to Love the Bomb
By Stephen J. Butler |
 Archives |
A father of four teenage sons once told me that parenting for him was an exercise of sitting in his armchair and gripping those arms as tightly as he possibly could. There was nothing more he could do. The second quarter's stock market performance has reminded me of this image. Those of us with money in the market have a reason to feel like the parents of four teenagers. We are trying to do the right thing, but we have to admit that events are out of our control. Fortunately, the vast majority of wild teenagers turn out just great if given enough time. In the end, I am confident that we will be able to say the same thing about the stock market.
My high school French teacher once caught some of us goofing off and was surprisingly lenient because, as she put it, "the wildest colts make the finest horses." The same could be said about the market. At times like this it is helpful to remember that the market dropped by a total of about 80% from 1929 through 1931, but it was up by about 50% in both '33 and '35 with a further bump of 35% in 1936.
With the prospect of this much volatility, it would be a mistake for someone to bail out at this point. Furthermore, the majority of investors are those of us making ongoing contributions to retirement plans. For those short of actual retirement, the current market weakness represents an excellent time to buy. We should be praying for these periodic opportunities.
Meanwhile, our economy remains relatively robust. My travels in the business community offer plenty of anecdotal evidence of this; but in addition, even Alan Greenspan testified before Congress earlier last week about the signs of economic strength. The stock market and our economy remind me of the distinction between Italy and its government. While that country has prevailed as the sixth largest economy in the world, it has managed to accomplish this with a revolving door of dysfunctional governments. Similarly, there are times when our economy can operate independently of the excesses of the stock market.
In the face of what can only be described as a blood bath, there are some of us who feel a need to at least do something. Anything. For anyone feeling this urge, there are a few constructive steps to consider.
First, review the spread of investment types to make sure you have enough diversification among large and small company stocks as well as growth stocks and value-oriented, dividend-paying stocks. Ideally, your mix should also include a few Real Estate Investment Trusts (REITs.) Regular readers of this column will recall that I am an advocate of maintaining a mix of investment types which leads to what I call "the path of minimum regret." With REIT's up about 17% this year, and small companies generally making some earlier gains, you can witness the extent to which "every dog will have its day" in the securities industry.
Re-balancing your account at this point midway through the year can also make sense. To the extent that these wild market forces have changed whatever your original percentage allocation you might have had among different investment types, the act of re-balancing will force you to sell a portion of your winners and buy some of what is now deeply depressed. Re-balancing reduced risk in the '90's, but it did not generate as high a total return as leaving the original allocation untouched and "letting the winners ride." Now, with a market reflecting its more normal pattern that includes both winners and losers, the re-balancing exercise is set to redeem itself as a valuable investment tool. Historically, regular periodic re-balancing has been shown to generate an additional 1% of earnings per year. Compounded over time, this seemingly small annual increase can lead to substantial additional gains while reducing volatility or risk. On a $10,000 annual contribution, the additional 1% can add up to an additional $75,000 in twenty years if it bumps the return to 10% instead of what would have been 9%. In thirty years, the difference is $350,000.
Also, with a market that has imploded, dividends finally mean something again. As a group, the dividend-paying stocks of the S&P 500 index have been flat so far this year while the total index has dropped by 13%. Many investors forgot about dividends back in the '90's when they amounted to an average return of about 1.2% of the S&P 500. Today, they amount to about 2%, and this is money we are paid for holding on to stocks regardless of whether they go up or down. Some utilities are paying dividends that amount to as much as 9% when compared to the stock price.
To put it bluntly, the world has NOT gone to hell in a hand basket. It's just the stock market that has undergone a major correction. In the traditional brokerage world, there is the practice of encouraging clients to "sell down to the sleeping point." This is a practice of selling enough of an investor's portfolio so they can sleep well at night. To sell out now is to do so too late. Instead, it is better to remain invested and to be content with some minor course-correcting that will capitalize on some great buying opportunities.
BUYandHOLD does not offer or provide any investment advice or opinion regarding the nature, potential, value, suitability or profitability of any particular security, portfolio of securities, transaction or investment strategy. Any investment decisions you make will be based solely on your evaluation of your financial circumstances, investment objectives, risk tolerance, and liquidity needs. The securities markets are subject to the risks of fluctuating prices and the uncertainty of rates of return and yields inherent in investing and past performance is no guarantee of future results. |
