During Recessions and market corrections, it is often difficult if not painful and fearful to watch investment accounts decline in value. Years of hard work often created these portfolios; and in many cases, the account owner is now living off of the income with time no longer on their side to start over. But, the same event robbing the value from the portfolio is also creating a significant opportunity.
My article’s title this week may reflect the sentiment of many investors as they watched their portfolio values shrink after the December 2008 bounce. The January statements for many investors returned lower values than the preceding month. February was no different, except the decline may have been worse. The declines did not stop, at least for the indexes, until March 9th. But to address the quote and the fear, let’s see if the concern is really plausible.
Most investors will be diversified, owning at least five or six mutual funds if not more. While the investment markets declined in January and February ultimately reaching a new low for this recession, the declines cannot continue in a straight line as the quote may suggest. If the portfolio is diversified, then only a portion is invested in actual equities or stocks. The balance will be in cash, bonds, or other asset classes. During this recent decline, the equity portion was the segment creating most of the losses; so if anything were to go to zero, that would be the segment. But, is it really possible to go to zero? Most mutual funds are diversified, owning 30 to 200 different holdings. And if you own more than one equity fund, the diversification most likely has grown substantially. Therefore, for this segment to go to zero as the quote suggests, all 30, 200, or 400 companies owned by the equity funds will need to become worthless on the same day. Possible? Maybe, but clearly not plausible.
The market did what it has always done and that is shake out those not committed to their long term goals. Investors have only so much pain then can withstand; and during volatile markets as we have experienced, many investors sell at or near the bottom in the hopes of protecting the remaining value. While this action may protect the remaining value from additional declines, it often assures the investor of missing a significant part of the recovery. This is why many investors have dismal long-term investment performance track records.
During times like we are experiencing, many companies take advantage of the opportunity to offer “safety” as an option. And for those who have been scared by the market, the “safe” option sounds like the right thing to do. It is very easy to sell water to someone who is thirsty; and while this may appear to be the correct step, it could do more harm than good. For those who need to consume their entire savings within the next few years, avoiding investment risk would be wise. However, if long term is still an objective for a portion of the portfolio, shifting to a safe investment may lock up the investment for months or years and may avoid losses. But, it could also cause the investor to miss buying in the market near the low.
For individual investors, once assets have been sold it is rare the investor would be willing to re-enter the market very quickly. Thus, they may potentially miss recovery rallies that take place in the weeks or months following their sell. I am not suggesting turning a blind-eye to the markets and not managing investments through difficult times. Taking steps to reduce equity positions during the last eighteen months would have been helpful. But at the same time, adding selectively to equity positions during these periods when the markets were setting new lows would also have benefited the portfolio.
Since the start of last October, there have been more moves in the market taking only weeks that in the past would take a year. The first was a 35% drop in value from October 1st through November 20th. Then the bounce of 24% up which peaked on January 6th. Without more good news, the markets then drifted lower dropping a total of 27% by March 9th. And now, the markets are taking another bounce up of 21% so far through the 23rd. Ignoring investment portfolios during these times clearly can result in missed opportunities.
To avoid making significant mistakes, each investor needs to evaluate their objectives. If part of the portfolio will be needed to create income in five, ten, fifteen, or more years in the future, then clearly long term is still a part of the objective. However, if income is being taken now, then a portion of the portfolios needs to be in cash or conservative bonds to meet the current income needs for the next year or so. Conservative investments in excess of this amount may then be used to gingerly move back into the markets. Looking back in two to four years should provide proof that investing during market lows provides better than average returns.
For help with managing investments contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area.