Sunday, January 27, 2008

Financial Markets In Turmoil

The media headlines continue to scream about recession and bear markets and the global stock markets continue to sell off with record volatility. Considering we haven't experienced such a violent downturn in the financial markets in several years, I thought I would provide some insight into the history of the stock market to underscore that fact that successful investing requires discipline and a long-term perspective.

Invariably, the individual investor looks to sell out of the market during turbulent times, hoping to spare themselves the pain of market declines and financial losses. This desire to avoid pain is human nature and natural. But in the end, this "market timing" approach to investing can result in significant long-term under performance of an individuals financial assets.

It is my view that for most investors, market timing does not pay. For example, during the years 1985 through 2006, the stock market was open for trading for a total of 5,297 days. Over that period, the S&P 500 produced an average annual rate of return of 12.12% for an investor who was invested in the market for all 5,297 trading days. However, an investor who missed the 10 best trading days during this period, but was invested for the remaining 5,287 days, achieved an average annual return of only 8.56%. An investor who missed only the 40 best trading days achieved a pitiful return of only 1.87%. Finally, an investor who missed the 70 best trading days during the 5,297 day period actually achieved a negative return of <3.02%>.

Clearly timing the market is a risky proposition for the long-term investor. Although some may be successful at market timing sometimes, most are unsuccessful over the long-term. I believe that having an investment strategy that emphasizes the concepts of Modern Portfolio Theory (i.e. using asset allocation, style management, and portfolio rebalancing) will provide a favorable risk/return result of time by managing a portfolio of financial assets in the most efficient manner possible.

Develop a sound financial plan and investment strategy that is appropriate for your personal goals and tolerance for risk and then stick to the plan for the long run, regardless of the current short-term market conditions.

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