For many Americans, recent unsettling international and political events evoke memories of other turbulent times in our history - from the attack on Pearl Harbor to the Persian Gulf War. Are there lessons to be learned from these pivotal, historical moments? When it comes to our financial markets, the answer is quite possibly "yes." It may be more important than ever for you to keep a historical perspective when you make your next set of investment decisions.
In the weeks following the tragic events of Sept. 11, many American investors have faced increased anxiety about the future of our financial markets and the long-term effect that international conflicts may have on their investments. How will your own portfolio fare in the months ahead? How should you approach the market? While no financial adviser or market analyst can offer definitive answers, and while past performance is no guarantee of future results, you can learn valuable lessons by studying how markets reacted to significant turmoil in the past.
While markets historically have dropped sharply following major turbulent events, they also historically have rebounded in successive weeks and months. In some cases, the market even gained strength from the momentum of a wartime economy.
Consider the following historical events and the market's reactions. (But, remember, past performance is no guarantee of future results.)
• December 1941. Some historians have compared the recent terrorist activities to another attack on U.S. soil - the bombing of Pearl Harbor on Dec. 7, 1941. Similar to the market in early 2001, the 1941 stock market was in significant decline even before the Pearl Harbor attack. Then, from the attack to Dec. 10, 1941, the Dow Jones Industrial Average fell 6.5 percent (Forbes.com, Sept. 19, 2001). Nevertheless, only 22 days later, the Dow had increased 3.8 percent and a powerful rally commenced in April 1942 when the tide began to turn in World War II (Investor's Business Daily, Sept. 21, 2001). On the heels of military success, the Dow nearly doubled during the next three years.
• November 1963. The assassination of President John F. Kennedy caused some investors to panic, resulting in a 4 percent Dow Jones decline during the trading day of Nov. 23, 1963 (Ibbotson's 2001 Yearbook). Nevertheless, the market rallied quickly, recovering all of its losses and more in the days that followed.
• January 1991. Following Iraq's invasion of Kuwait in August 1990, the U.S. stock market experienced months of uncertainty as the United States deliberated its response. Then, in the weeks leading up to the Gulf War ultimatum - from Dec. 24, 1990, to Jan. 16, 1991 - the Dow Jones declined 4.3 percent. (But, remember, past performance is no guarantee of future results.) Once the United States launched Operation Desert Storm against Iraq, the market rallied and the Dow increased 19.8 percent within 63 days.
Studying historical market recoveries may help you gain a new perspective on your portfolio's performance today. While stocks may continue to fluctuate in the weeks and months ahead, this volatility need not disrupt your long-term investment plan. History has demonstrated that markets are resilient enough to rebound from natural and man-made disasters. It is important that you stay focused on the financial goals you and your family have established. Continue pursuing prudent investment strategies for achieving those goals. Remember, if your time horizon is years into the future, your portfolio has time to recover from market volatility.
A recent Washington Post poll found that 64 percent of Americans say they trust their government to "do the right thing" just about always or most of the time - the highest level of trust in government since 1966 and nearly double that expressed in 2000 (Washington Post, Sept. 29, 2001). With so many Americans making patriotism part of their daily lives, have you considered adding government securities to your investment portfolio?
Last year, fixed-income investments outperformed stocks for the first time since 1993. Today, including U.S. government securities in your portfolio may provide more than patriotism or reduced investment risk; these securities can provide diversification that have the potential to help your portfolio weather a volatile market.
Government securities come in many shapes and sizes. These tend to be the most popular: treasury bills (maturities up to and including one year), treasury notes (maturities between one and 10 years), and treasury bonds (maturities between 10 and 30 years). Treasury securities carry one of the lowest credit risks of any investment, because they are backed by the federal government. They are also free from state and local taxes.
Many other U.S. government agencies issue short-term notes, bonds, and certificates to finance their specialized operations. Here are some examples: mortgage-backed securities issued by the Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), and Federal National Mortgage Association (Fannie Mae).
Most agencies provide maturity dates and fixed interest rates, but, unlike securities issued directly by the U.S. Treasury, only a few of these agencies are backed by the full faith and credit of the federal government. For this reason, yields on these securities, as well as the risk, tend to be higher than those issued by the U.S. Treasury.
Despite an 18-month bond rally, some analysts note that inflation fears could deflate the boom. Inflation risk - the risk that your bond's fixed interest payments will not keep pace with inflation - could influence bond investors if inflation does, in fact, increase in the years ahead. And as the federal government increases spending, long-term interest rates could rise, thus decreasing the value of bonds.
Despite these risks, government securities still may be an appropriate choice for your fixed-income needs. So far, the government's position that any fiscal stimulus pumped into the economy will be short term has helped sustain the bond market. And the government's continuance of a bond buyback program, begun in January 2000 to retire $70 billion in 10- and 30-year Treasury bonds, has helped decrease bond supply and increase prices on long-term bonds. (Business Week Online, Sept. 19, 2001) The bond buyback program was halted from August 2001 to October 2001. There is no guarantee that this buyback program will continue.
Kathleen Adams, RDH, BS, is a financial adviser with Waddell and Reed (www.waddell.com). She is currently trying to initiate money-management workshops for hygiene students and specializes in working with dental professionals. She can be reached at (800)210-1357.
