These articles are published for general information purposes and are not an offer or a solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to
Financial market volatility can sometimes be unnerving. Some investors respond to market uncertainties with a “wait and see” attitude, staying out of the market, watching what happens and waiting for what they think is an opportune time to invest. However, this approach may sometimes do more harm than good to investment returns.
Consider cost of waiting
Many investors try to predict the movements of the financial markets, but it is easy to guess incorrectly. Research suggests that investing long term and weathering the ups and downs may offer better long-range growth potential than missing even a modest percentage of the best performing intervals in an investment period.
For example, the 1994 index-based study, “Stock Market Extremes and Portfolio Performance,” University of Michigan from the University of Michigan and Towneley Capital Management Inc., compared the consequences of remaining invested in U.S. stocks versus trying to time the market. It is important to remember that past performance is not indicative of future results. The study found that
c Each dollar invested in the stock market at the beginning of 1963 would have grown to $23.30 by the end of 1993.
c By omitting the 90 top-performance days out of that 31-year period, each dollar would have grown to only $1.10 with almost as much market risk compared to the buy-and-hold approach.
c A dollar invested for the period from 1926 through 1993 would have grown to $637.30.
c Leaving out the best 48 months — 5.9 percent of the entire 68-year period — a dollar would have grown to only $1.60.
Meanwhile, market risk was only about 17 percent lower compared to staying in the market for the entire time. The study also found that most of the gains for the periods occurred in a short time. For instance, 95 percent of the gains from 1963 through 1993 occurred during the best 1.2 percent of all trading days.
Harness the power of compounding
Time is another reason not to postpone investing. Time can work for you if you invest early — or against you if you procrastinate. Investing early on gives your money more time to compound. Thanks to the power of compounding, the longer the time horizon, the less you may need to contribute to meet your financial goals.
Consider this example: Suppose you need $250,000 in 20 years. You could reach this goal by investing $5,700 annually at a 7 percent hypothetical average annual return. But, if you wait five years to start, the minimum annual investment jumps to $9,298. The five-year wait costs you an extra $25,470 in contributions. Note that this example is hypothetical and for illustrative purposes only. Figures do not represent any actual investment’s performance or yield. Estimates of future performance are based on assumptions that may not be realized.
Adopt systematic approach
To help overcome tendencies to procrastinate or to try timing the markets, investors may wish to consider dollar-cost averaging. This disciplined investment technique may help market fluctuations work in your favor.
Dollar-cost averaging involves investing a fixed amount in the same investment, such as a stock or mutual fund, at regular intervals over time, regardless of price fluctuations. You buy more shares when prices fall, and fewer when prices rise — which has the potential to lower your average cost per share over time. By investing gradually, you reduce the risk of investing all of your funds at a peak price. Investing steadily — according to a schedule — may also help you focus less on short-term volatility and more on the long-term potential of your investment program.
Note that dollar-cost averaging does not guarantee a profit or protect against losses in a declining market. You also should consider your ability to continue investing through periods of high and low price levels.
Blend assets well
Asset allocation offers a way to help manage market fluctuations. If you diversify your investments across different asset classes, you may be able to reduce the overall risk in your portfolio. Of course, there is no guarantee that a specific asset allocation or mix of individual securities and mutual funds will satisfy your investment objectives or generate a certain amount of income.
The right asset allocation for you — the types of asset classes to hold as well as how to proportion your money among them — depends on factors such as your investment goals, tax status, risk tolerance and time horizon. Asset allocation begins with broad asset categories such as stocks, bonds, cash and, in some cases, alternative investments.
For example, some investors seek the return potential of stocks, but are concerned about short- and long-term price volatility. They might include bonds and cash in their portfolios to help cushion the impact of stock market swings. Other investors may seek the relative stability of principal and current income of bonds and cash, only to find that the return potential is not enough for their needs and might not keep up with inflation. These investors may want to include some stocks in their portfolio to help enhance their potential for return and keep inflation in check.
Alternative investments
Asset allocation may go well beyond the asset classes, to include alternative investments. Alternative investments include: real estate and real estate investment trusts (REITs), real assets (precious metals, commodities, oil, gas and timber), private equity/venture capital, hedge funds or fund of funds, managed future funds and inflation-indexed securities.
Within an asset allocation context, alternative investments are intended to provide some degree of exposure to returns and standard deviations of returns that are generally not highly correlated with the investment performance of the equity, fixed-income and cash asset categories.
It is important to consider that many alternative investments may have less liquidity, higher investment vehicle minimums, unconventional frequency and methodology of pricing, extended investment time frames and/or lockup periods, unusual risk/reward profiles, less predictable timing for capital inflows and outflows, higher fee structures and fewer regulation requirements. Alternative investments may not be appropriate or suitable for all investors.
Dale Ishida Suezaki is financial adviser at Morgan Stanley DW, 329-7979.
These articles are published for general information purposes and are not an offer or a solicitation to sell or buy any securities or commodities. Any particular investment should be analyzed based on its terms and risks as they relate to specific circumstances and objectives. People should check with their tax and legal adviser before engaging in any transaction involving IRAs or other tax-advantaged investments.
