Develop a Sound Investment Plan
When the stock market heads south, is your first instinct to sell stocks and get
into something safer?
With a well-planned portfolio, that’s probably the last thing that you should be
doing. After all, a plan tailors a mix of stocks, bonds and cash equivalents to
your particular financial goals, your time frame and your tolerance for investment
It takes into account:
• the risk/reward characteristics of each class of investment;
• the short-term volatility and long-term superior return of stocks;
• the steady income and interest-rate sensitivity of bonds;
• and the risk-free principal, but low and fluctuating yields, of T-bills and other
money market investments.
Own stocks . . .
You own stocks because, as a whole, equities have tended to increase in value over
time. There are several related reasons for this fact. To begin with, stocks represent
an ownership interest in the companies that issue them, and successful companies
generally produce increasing profits—some of which are paid to stockholders as dividends.
Investors seek stocks of companies that they expect to do well in the near future,
and willingly pay a price based on that expectation. When a growing number of buyers
pursue a limited inventory of stocks, the laws of supply and demand drive prices
. . . but consider the risks.
On the other hand, as we saw in 2000 and 2001, stock prices often decline. Corporations
may have problems that reduce or eliminate their profits. Changing interest rates
and business cycles can drag whole categories of stocks or the entire market down.
And it’s important to keep in mind that the daily movements of the stock market
may be largely driven by emotion. Traders and speculators—as opposed to long-term
investors—tend not just to react but to overreact to each tidbit of market news.
With daily volatility and business cycle trends, the stock market has, over the
years since World War II, experienced a “correction” of 10% or more every eight
months on average. And in 11 of the past 50 years, stocks, as measured by the Standard
& Poor’s 500-stock index, finished the year lower than they began it.
Certainly, recent history has been more encouraging. From the Gulf War to October
27, 1997, the market achieved 84 months free of corrections—the longest such period
on record. Although we have since experienced one sharp, brief correction and one
bear market, the S&P 500 only has had two down years in the last 19. Nevertheless,
we have no guarantee that this pattern will continue.
Make a plan and stay with it.
What this means is that the stock market, although an excellent long-term investment,
is no place for money that you’ll be needing in the next year or two. Equally, at
present dividend levels, stocks cannot match the income production of bonds. And
neither stocks nor bonds can protect your principal as cash equivalents do. So your
plan combines the three to meet your needs—and there’s no cause to abandon it reacting
to short-term stock market swings.
Of course, you will want to review your plan periodically with your financial adviser
to confirm that it’s structured to meet your changing needs and ensure that market
trends have not knocked it off the course that you’ve set.
Time to rebalance?
Relative performance of the various assets in your investment portfolio can move
you off the risk profile that you chose when you put your investment plan into action.
The obvious example of this situation is the spectacular performance of the U.S.
stock market between 1995 and 1999. If you moved your stock gains into bonds each
year, you would have sacrificed further gains, but you would have protected your
portfolio from the full effect of the more recent bear market.
You won’t necessarily want to rebalance every quarter, or even every year. For one
thing, there will be transaction costs—unless the transfer is between mutual funds
in the same family—and tax consequences, if the assets are not in a tax-deferred
retirement account. Also, markets tend to move in trends, and you may not want to
cut back on your stock holdings at a time when stocks are booming.
So you probably won’t want to rebalance if your allocation is just a few percentage
points off target. Instead you might choose to wait till the imbalance reaches 5%
We can help you in matching an asset allocation to your needs, and keeping it on
target through changes in market conditions and your financial goals.