Lessons From the Great Fall
In the past ten years, we’ve learned a lot of lessons. Though the global financial crisis seems like a distant memory, this is only the 10th anniversary of the onset of a great recession. In addition, we’ve experienced headline-grabbing events such as the introduction of the iPhone, the election of the first black president in our country’s history, and the spectacular recovery of our economy. In our first newsletter for the new year, I’ve attempted to summarize the last decade and how it pertains to managing your financial resources.
Stocks have proven to be the best investment for the long term. The market indices have recovered their losses and gone on to record highs. For those who were at or very near retirement, the opportunity to recover all of the losses was near impossible. However, if they kept some of their portfolio in equities, they will have time to recover some. Studies show that many savers/investors had as much as 80% in stocks in their 401k and IRA. The key takeaway here is that the closer you are to retirement or your target financial goal, the more conservative your asset allocation should be (fewer stocks). The further your goal is in the future, the more risk you can afford to take.
The market has always recovered. Eight of the last ten years were positive stock market returns. However, many people continue to panic in a bad economy and cash in, which means they miss out on the bull market that inevitably follows. The lesson is to have a plan you can rely in the event of a financial crisis. For example, a portfolio plan that called for periodic rebalancing would have buffered you from some (but not all) of the carnage of the meltdown. Having a well thought out plan doesn’t make you water proof, but it can act as an umbrella.
Save, save, save. Of all the strategies for accumulating wealth, the most effective is in your own hands. While income or job loss will affect your ability to save, when you can you should attempt to lock in automatic saving habits. One way is to increase the amount you’re saving as your income rises. We consult on a number of 401k retirement plans and I have the opportunity to conduct employee seminars on investing and saving for retirement. An increasing number of plans have an automatic feature that allows the participants to automatically increase their percentage of contributions. I always encourage employees to take advantage of this feature whenever possible.
Ignore the noise. No matter what the market environment is, the airways are always full of doom and gloom strategies. You will always hear about the “magic bullets” for beating the stock market. Whether it’s buying gold or trading commodities, someone always has a surefire way to easy wealth and they almost always claim to have predicted the last market up or downturn. My favorite is the guy who has written the book on how to beat the market and he is giving it away. Really? Along with the hucksters, there are also the market and economic forecasters. These are likewise almost always wrong. The point is to stick to your own long term investing plan.
Diversification is like mixed vegetables. It’s good for you. The purpose in having a well-diversified portfolio is that it will protect you from taking a total loss in adverse markets. Different assets classes react differently; so when one area might be taking a hit the other(s) may be doing fine. It is always a good idea to have an allocation to high quality assets like the U. S. Treasury. As I mentioned earlier, the younger or further you are from your goal, the more risk you can tolerate.
Real estate is not necessarily a great wealth builder. In the financial crisis, residential real estate was the epicenter of the meltdown. The average home value declined by over 20% and in certain parts of the country, by well over 50%. Historically, the home has been thought of as a great source of wealth accumulation, but the fact is the historical returns of real estate are about ¼ that of stocks. Residential real estate does not have the advantages of other assets. It is not easily sold and its value is totally dependent on local market conditions. Arguably you are relying on finding one buyer. While your home should certainly be part of your wealth, it should not be the main source.
Thank you for joining me as we look forward to what the next decade brings! If you have any financial questions, please feel free to reach out.