Last issue, we covered the first two cornerstones of investing: defining your goals and diversifying your investments. Now we will wrap up these foundations with discussing the need to stay invested and periodically review your portfolio.
This L Style column will cover the third cornerstone of staying invested. Be sure to “flip it” to the G Style column to learn more about the final step, periodically review your portfolio. .
Cornerstones of Investing
To realize the potential long-term returns of investing in stocks – and allow the risk-buffering effects of diversification to work for you – it’s important not to get caught up in short-term events.
Market “shocks” are no big surprise. History shows that where there are markets, there is likely to be volatility. In fact, there have been 14 “down” years in the U.S. stock market from 1946 to 2007. While some of those occurrences have been isolat- ed, they were followed quickly by upturns. When you look at the markets with a long-term perspective, it’s clear that dramatic rises and falls have been regular events, not rare exceptions.
The High Price of Market Timing
While history suggests that market volatility is just part of “business as usual,” and that dramatic declines in the markets have often been followed by dramatic rises, it also shows that these changes come with a timing no one can consistently pre- dict. Since there is no way of knowing when the best or worst periods will occur, jumping in and out of investments – or “market timing” – doesn’t work for most of us. Selling when the mar- ket moves down could mean missing periods when stock prices begin to increase and recover – and that can be very costly.
How Realistic are Your Expectations of the Stock Market?
Set realistic expectations. To avoid jumping in and out of investments, it helps to take a long-term view and not expect that every year will be a great one. For the 25 years through December 31, 2005, the average annual return for the Dow Jones Industrial Average was 11.21%. But history shows it’s probably not realistic to expect it to do that well over a longer period. After all, the Dow’s 50-year average return is just 6.65% through year-end 2005.
Keep Current Events in Perspective
It’s also important to take a long-term view of events outside the markets. While news headlines can affect the markets, history has shown that bad news doesn’t necessarily translate in to bad results for long-term investors. While past performance is no guarantee of future results, the Dow Jones Industrial Average has often declined steeply in response to crises, and then risen again in the future.
To enable you to spend time in the market, rather than trying to time the market, it’s important to choose a level of potential volatility or risk you can live with. It can also help to remind yourself that you’re investing for years, even decades from now – when headline news is likely to be very different.
Crisis Events, Dow Declines and Subsequent Performances