It has often been said that there are only two certainties in life: death and taxes. As investors, we face a third, and sometimes unnerving, reality in that financial markets do not move in only one direction. They rise and fall—sometimes sharply—in response to changes in the overall health of our economy. We can easily forget that fact during good economic times, but the market always stands ready to offer us a gentle reminder. So far, that's just what 2008 has done.
It's nearly impossible to read the paper or watch the news without hearing dire warnings about the subprime “meltdown,” the housing market “collapse,” and “dismal” job growth, which are hampering our economy. These, and other concerns, have many prognosticators calling for a U.S. recession in 2008. We certainly don't dismiss these concerns lightly, and we are monitoring conditions carefully.
But such attention-grabbing language, while currently in vogue, runs the risk of misdirecting our attention from the bigger picture and the ultimate goal. As investment professionals, we construct portfolios around the important concepts of diversification, time horizon, and risk tolerance. In times of uncertainty, we ask you to reflect on two important questions:
- How long will your money be invested?
- Are you comfortable riding out the market fluctuations that your portfolio experiences?
The period from 2000 to 2002 is widely regarded as one of the worst bear markets in U.S. stock market history. Stocks, as measured by the S&P 500 Index, lost 38 percent of their value during those three years. Yet, a diversified portfolio of 50 percent stocks/50 percent bonds would have suffered only a 6-percent decline. Of course, that balanced portfolio would also have appreciated less from 2003 to 2007, when stocks rocketed ahead by 83 percent. The table below shows the impact that portfolio diversification can have in up and down markets.
| 2000-2002* | 2003-2007* |
100% stocks - S&P 500 | -38% | +83% |
100% bonds - Lehman Aggregate Bond | +33% | +24% |
50% stock, 50% bond | -6% | +52% |
*Hypothetical cumulative return for period indicated
After five consecutive years of strong stock market returns, a pullback should not be unexpected or cause us to drastically change course. It is simply part of the normal economic cycle. The key, and our role as your financial professionals, is to appropriately diversify your portfolio to align with your investment goals, time horizon, and risk tolerance. That is what we do in both good and difficult times—and that is what we continue to do now.
