Fear is a powerful emotion and market losses can be fear inducing. But history shows that emotion is a poor compass for charting your investment course.
While the U.S. stock market, as represented by the S&P 500 Index, has risen a stunning 205.66% as of March 31, 2015, since its low on March 9, 2009, some investors are still reluctant to participate after the turbulence that accompanied the 2007-2008 “Great Recession”.¹
Fleeing the market certainly may have felt like the right thing to do in the depths of the financial crisis. However, history shows that making investment decisions based on emotion has rarely proven successful. Greed may have led an investor to own too many technology stocks when the bubble burst on that industry in 2000. Earlier, fear may have caused investors to cash out of stocks following the crash of 1987 and miss some or all of the subsequent rebound.
Fast forward to 2015. The reality is that investors who missed the extraordinary rally that has occurred since March 2009 may have helped to put their long-term accumulation goals at risk. This is especially true for investors with shorter time horizons, such as those approaching retirement.
Consider the following: From 2010 through 2014, U.S. stocks recorded an average annualized return of 15.5%, compared to 0.1% for money market securities.² The nearly nonexistent returns associated with cash-like investments could have a powerful impact on your purchasing power over time.
Maintain Balance to Manage Risk
One of the key determinants to investment success over the long term is having a disciplined approach to balancing short-term risk (stock price volatility) with long-term risk (loss of purchasing power). Finding a “middle ground” in your investment philosophy — and portfolio allocation — may go far toward helping you manage overall risk and realize your investment goals. Your Certified Financial Planner™ can help you to determine the correct balance between your risk tolerance and lifetime goals.
History indicates that stocks have tended to outperform other asset classes as well as inflation over long periods of time.³ However, investors who are too focused on the long term may over-allocate their portfolios to stocks — and over-expose themselves to short-term volatility risk. Alternatively, investors who are extremely averse to short-term risk may do the opposite and face increased risk of not meeting long-term objectives.
Easy Does It
How might this balanced approach to risk be used to get investors back in the market? One of the best ways to take emotion out of investing is to create an investment plan (called an Investment Policy Statement) and stick with it.
One of the best ways to ease into investing during a period of high market volatility is through a systematic investment plan called Dollar Cost Averaging (DCA).³ Dollar Cost Averaging is a process that allows investors to slowly feed set amounts of money into the market at regular intervals.
Although DCA does not assure a profit or protect against a loss in declining markets, it can help achieve some important objectives. First, it gives investors a measure of control while eliminating much of the guesswork — and emotion — associated with investing. Second, DCA can help investors take advantage of the market’s short-term price fluctuations in a systematic way — by automatically buying more shares when prices are low, and buying fewer when prices are high.
It is important to remember that periods of falling prices are a natural part of investing in the stock market. By maintaining a long-term focus and following a balanced approach to managing investment risk, you may better position yourself to meet your financial goals. Your Certified Financial Planner™ can help you identify which strategies may be best for your situation.
¹ Wealth Management Systems Inc. Stocks are represented by the daily closing price of Standard & Poor’s Composite Index of 500 Stocks (the S&P 500), an unmanaged index that is generally considered representative of the U.S. stock market. The percentage increase represents the gain through March 31, 2015. It is not possible to invest directly in an index. Past performance is not a guarantee of future results.
² Wealth Management Systems Inc. For the five years ended December 31, 2014. U.S. stocks are represented by the S&P 500 Index. Money market securities are represented by Barclay’s 3-Month Treasury Bill rate. Example does not include commissions or taxes. Past performance is no guarantee of future results.
³ Dollar cost averaging involves regular, periodic investments in securities regardless of price levels. You should consider your financial ability to continue purchasing shares through periods of high and low prices. This plan does not assure a profit and does not protect against loss in any markets.