Although you can't predict the future, you can prepare for it by sticking with a long-term investment plan regardless of current market conditions.
As a mutual fund investor, it's very easy to become wary of the stock market in light of its recent volatility. But, if you stick with a sound, long-term investment plan, chances are good that you will be rewarded down the road. That's the lesson to be learned from the market's recent uncertainty. Take a look at the events on Wall Street and what they mean to you.
Volatility often equals opportunity
Short-term market fluctuations should generally not dictate your mutual fund investment decisions. Although past performance is no guarantee of future results, over time, the positives of remaining invested have tended to outweigh the negatives. For example, according to Ned Davis Research, in the last 30 years, the stock market has dropped 10 percent or more only 13 times. Over the last 100 years, bear markets — an extended period of falling prices in the overall market — have lasted approximately 406 days, resulting in an average loss of minus 30.9 percent. A bear market is usually prompted when investors anticipate a decline in economic activity.
By contrast, bull markets over the past century have lasted an average of 735 days, resulting in an average gain of about 87.1 percent. A bull market is a prolonged period of rising stock, bond, or commodities prices. Under normal circumstances, these markets are fueled by optimism about company earnings and economic growth. So even if the S&P 500, Nasdaq and Dow Jones Industrial Average all declined in any given quarter, history suggests that these markets can and will bounce back.
Timing strategy usually doesn't work
While volatility may get you thinking about the best time to get in and out of mutual funds, resist the temptation. History again confirms that abruptly moving money based on expected future market conditions generally doesn't pay in the long run. Let's say you invested $10,000 in the stock market — represented by the S&P 500 Index* — and remained fully invested from December 31, 1995, through December 31, 2000. Your money would have grown an average of 18.33 percent annually to $23,196.*
Missing 10 best days can be costly
Yet, if you had missed the 10 best days during that bullish stretch, your return would have been slashed to an average of only 9.24 percent annually. In other words, you would have missed out on half of the return by being out of the market during those 10 best days. And get this: The return would have diminished to minus 2.07 percent if you had not been invested during the best 30 days.*
Fluctuation is part of the system
According to Henry J. Hermann, president and chief investment officer of Waddell & Reed Investment Management Company, occasional economic downturns should come as no surprise. "We have experienced them in the past, but not since 1990, so we've been spoiled," he said. That was particularly true in early 2000 when the S&P 500, Nasdaq, and Dow Jones Industrial Average leaped to record highs, reflecting a robust economy. Unfortunately, this created a false sense of security among many investors who had never lived through a bear market. "Downturns are a part of a free-market system and we shouldn't be shocked when they occur," Hermann added.
Bad news gives way to good
According to Hermann, there is good news accompanying the weaker economy. The Federal Reserve Board has been cutting interest rates, which has historically helped to stimulate the market. And President George W. Bush's tax cut may benefit investors. "Once the air is cleared, we believe that the stock market uncertainty should be behind us and we will have a better understanding about what is ahead," he said.
Although you can't predict the future, you can prepare for it by sticking with a long-term investment plan regardless of current market conditions.
As you read about market volatility, you may be tempted to focus on the best time to get in and out of mutual funds. However, trying to anticipate future direction could prove costly to your portfolio. Yes, the market can be volatile. But although past performance is no guarantee of future results, history shows that, over time, the positives of remaining invested have tended to outweigh the negatives.
* Source: Standard & Poor's. This data assumes the reinvestment of income and does not account for taxes or transaction costs. An investment cannot be made directly in an index. Past performance cannot guarantee future results. Large-capitalization stock performance is represented by the Standard & Poor's 500 Composite Stock Index, an unmanaged index of 500 common stocks generally representative of the U.S. stock market.
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.
