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October, 2014

BOTHERED BY THE MARKET'S RECENT SWOON? TAKE A NAP.
by LARRY

Do not invest in common stocks unless comfortable with its periodic instability. All too frequently formerly nervous investors pile into equities when they are up, feeling that this means NOW is finally a great time to invest. Yet just when most everyone is invested there is little new purchasing power and so shares, by the age old laws of supply and demand, begin on the slightest bad news, to slide and then to fall precipitously, even to have a rout as millions run for the exits and clog up the aisles of egress. Thus do folks every few years buy high and sell low, though most everyone knows that in principle the best tip for investors is the opposite.


As of this writing (10/15/14), once again the U.S. stock market is sharply off. There has been a succession of such down days over the past few weeks, wiping out most or all of 2014's prior gains. Ideally, the investor takes these fluctuations in stride. With a longer view, since 1926 the S&P 500 Index, another popular measure of stock market activity, has provided investors with typical total returns of 9.8% annually. Per Wikipedia, the value of a dollar invested at the beginning of 1970 in the S&P 500 Index (if left untouched and with dividends and capital gains reinvested) would have been just under $78 be the end of 2013. Micro-cap stocks have in a similar period had total returns of around 12% a year, though with greater volatility than for their larger equity cousins.

Thus, when for a day, week, month, or even a particular year the combined actions of millions and millions of investors, big and small, is to temporarily take average prices down, the reasonable response of someone who had invested with awareness of how stocks do give excellent returns over the extended timeframe (better in relation to inflation than just about any other common financial instrument), but with occasional hiccups along the way, is just to yawn, maybe even nap.



Still, humans are hard-wired, psychologists tell us, to be more impressed by having things of value taken away than by the retention or even addition of good value. It is natural, if looking at one's on-paper worth being quickly diminished, to want to do something, to stem the outward flowing tide, almost as if the bleeding away of our net asset values were a literal loss of life sustaining fluids. Yet this is probably the worst time to do what feels most normal, to sell off one's holdings, as to do so then is to rob oneself of what till now was seen as a share in the profits of valuable businesses. Worse, it is often to do so at a fraction of the price we had paid for this share in profitable concerns or at least a fraction of the elevated value the market may have so recently placed on it.


Future Value Variables
Initial investment:$10,000
Annual addition:$5,000
Years:40
Annual compound interest rate:7.4%
Result:$1,362,858
(Source: MoneyChimp.com, last updated 2013.)


If I find the urge to do something too great to be ignored, then it may be time to rebalance the portfolio. Suppose I have a certain percentage of our liquid assets in money market funds (maybe 10%), another chunk in bond assets of various maturities (maybe 30%), and yet another in equities (perhaps 60%, for instance). While money market account funds are stable, what tends to occur when the stock market is down is that people redeeming their stock holdings will put some of them into bonds or bond funds, thus lowering the yield on bonds and raising their market value. In addition, the loss of market value for the stocks or stock mutual funds portion of our net asset value reduces the whole portfolio, so even a stable asset, like a money market account, can rise as a fraction of the now diminished overall portfolio. In this scenario, then, the percentages will have gotten out of the intended balance, perhaps now standing at 12%, 34%, and 54%, respectively, for the money market, bond, and stock portions.

So, to restore the desired allocations, use some assets from money market funds and the rest from bond assets (which are up) to buy more equities (which are down) and thus get the nest egg back to 10/30/60% target levels for money market funds, bonds or bond mutual funds, and stocks or stock funds (the latter perhaps half invested with a low-cost S&P 500 Index exchange traded fund [ETF] and half in a low-cost small-cap ETF), in the process buying low (equities) and selling high (bonds).



It seems odd to say so now, when money market fund returns are near zero and 10-year Treasuries are yielding less than 2%, but historically money market funds have provided average annual returns of about 1.6% and intermediate-term bond funds yearly returns averaging about 6.0%.

A well rebalanced set of such assets in the following mix: 10% money market funds; 30% a blend of domestic and global intermediate bond funds; 30% in a low-cost S&P 500 Index ETF; and 30% in a low-cost micro-cap stocks ETF, if maintained in tax-deferred accounts, with no distributions taken, rebalanced annually or when equities are down 10% or more, would have provided average total returns of about 7.4% a year for decades.

While this is not a formula for getting rich quickly, it may well be a reliable means of overcoming inflation, keeping one's nest egg relatively stable despite market gyrations, and eventually having enough financial resources for one's retirement or for other worthwhile long-term goals.



According to MoneyChimp, a young college grad who starts setting aside assets in tax deferred accounts wtith an iniital investment of $10,000, annual additions of $5000, and average annual returns of 7.4%, could expect to have over $1,360,000 about when he or she expects to retire, four decades later. The table above represents this potential outcome. Clearly if he or she marries and has an equally frugal spouse, the figure could be double that amount.

Good luck with your own investing through the recent downturn and in the years ahead!



DISCLAIMER

Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)



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