By Sheryl Rowling
SAN DIEGO — Now that the High Holidays are over, many investors are nervously looking at the market. I thought this would be a good time to address some common questions.
When we know the market is going down, shouldn’t we get out of stocks?
The truth is that nobody knows what the market will do. Sure, the media “talking heads” all profess to know, but they get only attention for sensationalism, entertainment or being right the last time! What if you got out of the market and it shot up right after? Market increases tend to happen in spurts. If you miss only a few of the best days a year, your returns will likely not even keep up with inflation.
Shouldn’t we get out of bonds when interest rates can only go up?
Bonds produce ongoing income no matter what the stock market does. Many investors fear that when interest rates rise, their bonds will be worth less. This is only true of the bonds before maturity. Let’s say you buy a 10-year bond for $10,000 paying 4%. You will collect $400 per year and, at the end of ten years, you will get your $10,000 back. If, after two years, the interest rates rise to 5%, you won’t be able to sell your bond for $10,000. An investor would pay you less to get 4% when other bonds are paying 5%. As long as you hold onto the bond, you will still get interest payments and $10,000 at maturity. When interest rates rise, as your bonds mature, the next bonds you buy will pay more! So, an increase in interest rates is good for your portfolio – as long as you can handle the temporary paper losses.
I hold a diversified portfolio. When the market goes up, why doesn’t my portfolio increase by much?
With higher ups, comes lower lows. Think back to 2008, how would you feel about your portfolio losing 40% or more? To get returns like the Dow or the S&P 500, you’d have to be fully invested in just that one part of the market. And, you’d have to be willing to ride out the extreme falls. You’re better off in the long run with a diversified portfolio.
For example, Jack holds an aggressive portfolio with a long-term expected return of 10%, while Jill holds a moderate portfolio with an expected return of 8%. Here is a possible scenario:
Jack Jill
Investment $100,000 $100,000
Year 1 Loss ($20,000) ($8,000)
Year 1 Balance. $80,000 $92,000
Year 1 Gain $32,000 $22,000
Year 2 Balance. $112,000 $114,000
In this case, Jill came out ahead even though her average 8% return was less than Jack’s average 10% return. In year 1, Jill was okay losing only 8% when her friend Jack lost 20%. In year 2, she wasn’t pleased when her portfolio only increased by 24% while Jack gained 40%. However, considering the overall return for the two years, Jill came out ahead.
Remember that emotional decisions rarely make for good investment results. Consider consulting a Registered Investment Advisor.
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Sheryl Rowling is a certified public accountant, personal finance specialist, and principal of Rowling & Associates. She may be contacted via sheryl.rowling@sdjewishworld.com