Show #453 Airing Sunday, 11/9/08
It’s a tough time financially right now. That’s not news. But we do have news on how old fashioned common sense can see you through this 21st century money melt-down. And for our look back to the future, we turn to our “man for all financial seasons,” Certified Financial Planner Jonathan Herbruck from Concord Advisors.
Question: Jonathan, give us some perspective and explain how common sense can help us out today.
Answer: Here’s what we need to remember – during financial crises, stock prices suffer. However – although past performance is no guarantee for future results – stock prices typically recover over time.
Take a look at this chart: (for a larger view, please click on the graph)
This bar graph represents five historical U.S. financial crises.
- October 1987 – stock market crash
- August 1989 – U.S. Savings & Loans Crisis
- September 1998 – Long-term Capital Management’s bailout
- March 2000 – dot-com crash
- September 2001 – terrorist attack
In the short term, uncertainty from such external shocks can create sudden drops in value. For example, each portfolio posted negative returns one month after the October 1987 stock market crash. Over a longer period of time, however, returns were much more attractive, and investors who stayed the course reaped considerable rewards.
Question: Are you saying to hang in there? Take the long view?
Answer: First of all, everyone’s individual situation will be different and should you should consult with a financial advisor before selling your portfolio. I can offer that fear and uncertainty might lead investors to sell their investments during tough times, putting downward pressure on prices. Trading because of these emotions can be detrimental to a portfolio’s value.
By selling during downward price pressures, investors might realize short-term losses. This is compounded as investors wait and hesitate to get back into the market, possibly missing some or all of the potential recovery. The lesson here is that patience can pay dividends.
Question: Does this kind of financial market reinforce that a diversified portfolio (investments across types of industries and size of company) is the best way to go?
Answer: Diversification can also limit losses during turbulent market conditions. The dot-com crash in 2000 resulted in rather large losses for those invested entirely in stocks. In fact, every period analyzed actually produced a loss.
On the other hand, the balanced portfolio’s losses were less severe, and after five years it actually generated a gain.
One of the main advantages of diversification is reducing risk, not necessarily increasing return, over the long run. While stocks offer the potential for higher returns, the downside risk can also be extreme.
A diversified portfolio can help mitigate such extreme swings in value.
Government bonds are guaranteed by the full faith and credit of the U.S. government as to the timely payment of principal and interest, while returns and principal invested in stocks are not guaranteed.
Stocks have been more volatile than bonds. Diversification does not eliminate the risk of experiencing investment losses.
Looking back can help us plan for the future. Give Concord Advisors a call for a free initial consultation. My thanks to Jonathan Herbruck for his down to earth advice.
