Financial Focus/Taking “Timeout” from Investing Can Be Costly

If you’ve been investing over the past decade, you probably have good reason to be confused. From January 1995 through December 1999, the S & P 500 Index gained an average of nearly 29 percent per year. But from January 2000 through December 2002, that same index dropped, on average, more than 14 percent per year. The market rallied in 2003, but results are mixed in 2004. As stocks move up and down, what’s an investor to do?
First, you need to accept that, over the short term, the stock market is perpetually volatile. But over the long term, the stock market has always trended up. From the beginning of 1926 through the end of 2003, stocks (as measured by the S & P 500) showed a compound annual growth rate of 10.4 percent, according to the market research firm Ibbotson Associates. (Keep in mind, though, that past performance does not assure future results. Also, the S & P 500 is an unmanaged index that cannot be invested into directly.)
Of course, your investment horizon may be shorter than 78 years - so you may wonder if you could “duck out’’ of the market during “down’’ times. But that’s not really practical. No one can accurately predict when a down market will turn up or when a strong market will head south.
Consequently, if you take a break from investing, you could miss out on some growth opportunities.
Want proof? Let’s look at some numbers. Suppose you began investing in the stock market (as represented by the S & P 500) at the end of 1953. If you had stayed invested until the end of 2003, you would have earned an average return of 7.9 percent annually. But suppose, along the way, you had pulled out of the market from time to time. If you missed just the market’s top 10 days during that 50-year period, your return would have shrunk to 6.74 percent. And if you missed the top 40 days, your return would have eroded to 4.25 percent.
Want to see a shorter time frame? Look at the 11-year period from the beginning of 1993 through the end of 2003. If you had stayed invested the entire time, you would have received a 9.07 percent return. But if you missed the top 10 days, you would have gotten just a 4.05 percent return - and if you were out for the top 40 days, your return would have been a negative 5.81 percent. (All these returns exclude reinvested dividends and transaction or commission costs.)
Clearly, it can pay to stay invested. Still, it’s difficult to look at bad news on monthly brokerage statements. How can you ease this type of discomfort?
You can’t control market volatility. But you can blunt its impact by diversifying your investment dollars across a wide range of assets - stocks, bonds, government securities and certificates of deposit. While diversification doesn’t eliminate market risks, the more diversified you are, the less susceptible your portfolio will be to market downturns that hit one asset class particularly hard.
And there’s one more thing you can do: Keep your focus on the future and your long-term goals. That’s not always easy. It takes discipline and real commitment to keep investing during turbulent times - but the ultimate reward may be worth the effort.
This article was submitted by the local financial representatives of Edward Jones.