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Market Volatility Shouldn't Rattle a Good
Financial Plan
On Feb. 27 this year, the Dow Jones Industrial Average slid
416 points, the biggest drop since the market reopened after the
9/11 attacks. By early May, the market had more than made up
those losses and stood at record highs.
How did you react? Did you turn off the news? Did you call
your broker in a panic? Or did you call your financial planner
to see if your plan was solid?
It's easy to succumb to the urge to sell if the market takes
a header or buy if it's headed upward. But sudden action is
usually a mistake. In the late 1980s, Harvard psychologist Paul
Andreassen made news with a research project that found that
people who listened to market news actually made lower returns.
Why? Because those who sold — or bought — during a market swing
probably found a day later that the market was really running on
hype, not fundamentals.
You pay a financial planner to devise a financial strategy
that matches your risk tolerance and long-term financial goals.
No, there is absolutely no way to guarantee that you'll never
lose money. But if a plan truly matches you, the noise level on
TV shouldn't make a difference. So the next time the Dow spikes
or slides, ask yourself:
What's my plan? If you've worked with a good financial
planner, you should be able to articulate those goals all by
yourself or refer to an investment policy statement you made
together. Much of the riskiest investing, overbuying and panic
selling during the late 1990s and early 2000s could have been
avoided if individual investors had sought advice for achieving
long-term specific goals such as retirement or a college
education.
What's my risk tolerance? At your first meeting with a
planner, you should have discussed — and later filled out — a
form asking you a number of questions about how you handle risk
and what your expectations were about investment returns. You
might have had to do this more than once if your risk tolerance
was low but your investment expectations were high — low-risk
investors can't expect the highest returns. That's part of the
education process when you visit a planner.
Am I prepared to stay invested — no matter what? We
all remember the "Tech Wreck" of 2000. At the worst of
that downturn, investors bailed out of the stock market or
drastically cut back, only to get back in after they were
"convinced" that the market was rebounding. In
reality, they missed out on stock market gains during the early
stages of recovery, and that's costly in the long run. Of
course, some investors looking for that late 20th century
investment high also got into the real estate market, and they
perhaps learned a similar lesson when that market started
heading south two years ago.
In 2004, SEI Investments studied 12 bear markets since World
War II. Investors who either stayed in the market through its
bottom, or were fortunate to enter at the bottom, saw the
S&P 500 gain an average of 32.5 percent (not counting
dividends) during the first year of recovery. Investors who
missed even just the first week of recovery saw their gains that
first year slide to 24.3 percent. Those who waited three months
before getting back in gained only 14.8 percent.
Am I diversified? The NASDAQ lost 39 percent of its
value just in 2001, and another 21 percent in 2002. Meanwhile,
real estate investment trusts, which performed poorly in 1998
and 1999 when stocks were booming, had banner years in 2000 and
2001, performed so-so in 2002, and had an excellent 2003. Bonds
also returned well during the bear market. Your planner, based
on your risk profile, should have you in diversified investments
that fit your goals.
Do I still feel the same way I used to about returns?
Having a long-term investment plan doesn't mean make the plan
and leave it to gather dust. You and your planner should decide
when it's time for a review of your investment goals and your
feelings about them. An annual conversation makes sense if
nothing's going on, but life events like death, divorce, kids
moving out and illness are good reasons to do a head-to-toe
review of a financial plan.
May 2007 — This column is produced by the Financial
Planning Association, the membership organization for the
financial planning community, and is provided by Don McCarty of
Financial Decision Partners, a local member of the FPA.
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