As a child I found that my father became a lot more interesting when he stopped spanking me for some misbehavior. Over time, growing up in LA before the spanking began he would ask me, "What have we (meaning me) learned from this situation that clearly irritated him?" This became my opportunity to think really fast and come up with something intelligent so that I could demonstrate learning and reduce the chances of meeting the belt. So I became inspired to craft messages that demonstrated that I had good diction. I thank my father for my ability to choose words well.
I also learned from my father by example, that it was OK to ask for directions when trying to get somewhere. Unlike some of my friends I never thought it beneath me to ask for help rather than spend way too much time going in circles, not at all sure that I was going to get where I wanted to go. These two life experiences can be useful in investing too. Smart investors continue to ask their advisors, "What have we learned here?" Smart advisors demonstrate to the clients' satisfaction what they have learned that might be of value to them. Let's go back to the beginning of the last decade that some investors have called the Lost Decade, because as see thanks to Yahoo Finance, the period from 2000 to 2010 was the first time since 1926 that the stock market was relatively flat for a ten year period. Investors who added to their accounts did just fine. Those who needed to take money out didn't do well at all. Investors who didn't take money out of their accounts are glad they didn't as the market has enjoyed great upside volatility since 2009, but as you will see they could have done better. For a visual description please see:
Ask better questions: get better answers
To be better prepared for the good, the bad, and the ugly, one way to begin is by looking in the recent past. You may recall that your stock account doubled in the late 90s. So $500,000 in 1995 could have been worth $1MM on 1/1/00 with the S&P500, but down to $666,000 on 1/1/03. The buy and hold crowd was glad to see $1.1MM in 2007 and sad to see their account down -38% to $684,000. By year end 2013 these investors are breathing a sigh of relief with $1.4MM.
Rather than ride the stock market roller coaster , some financial advisors suggest more diversification may be helpful in limiting downside participation. Consider the performance of a portfolio 100% in stocks for the same time period, verses blended benchmark holding 60% S&P500, 20% Merrill Lynch Hi Yield Index, and 20% Case/Shiller Home Price Index. With the same starting value of $1MM on 1/100 and no withdrawals or contributions we see that the blended benchmark was down -17% instead of -33% on 1/1/03 so the account value was $833,000 instead of $666,000. Since the decline wasn't as severe the recovery was better reaching $1.3MM in 2007. By 1/1/09 the decline was -33% instead of -38%, which might not seem like much, but the account value was $912,000 instead of $684,000 which is a big difference. As of 12/31/13, the 100% stock portfolio stood at $1.4MM, but the more diversified portfolio finished the year over $1.7MM, 23% more money or a larger account balance of more than $326,000.
Those who swing for the fences may strike out
Instead of swinging for the fences with the buy and hope mentality those of us who are willing to learn may see that: the best offense is a good defense. And the best defense may be to see how to limit downside participation in a bad year. This is especially true when investors are taking money out of accounts to meet living expenses. You don't want to have to double your withdrawal rate to offset a severe market decline as that will probably not end well. You may have increased your odds of running out of money before you run out of time. Since you are more likely to live longer than you imagine it is better to see how you can stay in the game after the grits hit the pan again.The opinions voiced in this article are for general information only. They are not intended to provide specific advice or recommendations for any individual and do not constitute an endorsement by NPC. To determine which investments may be appropriate for you, consult with your financial professional. Please remember that investment decisions should be based on an individual's goals, time horizon, and tolerance for risk. Investment in stocks will fluctuate with changes in market conditions and indices are unmanaged measures of market conditions it is not possible to invest directly into an index. Past performance does not guarantee future results. Neither diversification nor rebalancing can ensure a profit or protect against a loss. Examples used are for illustration only. Actual results will vary.