Endure the Market Dip (Guest Commentary)

The market downturn of 2000-2002 has been the most rigorous challenge investors have faced in many years. If you are tempted to abandon your strategy during this volatility, consider the following:

• Is your portfolio working as designed?

The issue isn’t whether you’ve experienced losses since early 2000, but whether your portfolio has escaped the full effect of a declining market. Look at your portfolio’s total return over one, two, five and 10-year time frames, and compare these returns to U.S. and foreign market benchmarks, as well as average performance among managed portfolios. Your diversification strategy should focus on risk management, not just return maximization. When comparing portfolios with the same average return, the one with the lowest volatility will experience a higher annualized return over time.

• Are you on track with your original goals?

During 1995 through 2000, U.S. stocks came a long way very quickly. Although you may have lost ground in the wake of the market slide, you also might find that your long-term wealth accumulation strategy is on track. If you have the same retirement goals, investment time frame and earnings capacity, your current portfolio strategy should still be appropriate.

• Make tactical adjustments.

Diminished economic performance and lower expected investment returns may require adjustments to household spending, savings rate and risk exposure. Review your portfolio to determine if rebalancing or a change in asset allocation is called for to better fit your risk profile.

• Consider the importance of an investment plan.

Your portfolio should be designed to strike an acceptable balance between risk (short-term volatility) and return. The alternative to a carefully-planned portfolio structure is market timing and active trading. These strategies may seem useful in theory. But in past cycles, market timers as a group have historically failed to avert risk, avoid losses or enhance returns on a risk-adjusted basis. The current downturn is no exception. According to the Hulbert Financial Digest, a service that tracks performance of leading market timing newsletters, less than 7 percent of the timing advisory services outperformed the total market for the 10-year period ending June 30, 2001.

• Understand the statistical return history of asset classes.

Market performance during the 1990s was unusual from an historical standpoint. Before the stock market boom ended in 2000, stocks had racked up five consecutive years of 20 percent-plus returns, which is three years longer than any other time in modern history. But abnormally high and low market returns tend to balance out over time — a statistical principle known as mean regression.

• Are your return expectations reasonable?

Despite stock price multiples that are still on the high end, three in five investors expect double-digit stock returns over the next decade, according to a recent survey of investor sentiment. Many economists, academics and industry leaders have warned investors to expect much lower average stock returns in the next ten years, with total return estimates ranging from 6-8 percent, as compared to an 11 percent annual return since 1926. Carefully weigh your underlying assumptions about market performance, as these will affect your decisions about risk, portfolio allocation, spending, saving and even retirement.

• Are you a patient investor?

The stock market might stay within a lower trading range until corporate earnings recover. P/E ratios are still considered high at 21 times earnings. So, investors may have to be patient as they await a turnaround in their portfolios. Stock prices essentially reflect the state of the economy, the prospect for corporate earnings and the overall demand for equities. These factors, and investors’ interpretation of the outlook for the economy and earnings, affect prices investors are willing to pay to participate in growth.

Intelligent investing will involve compromise and tradeoffs in any market environment. Equipped with a clearly defined investment policy and a portfolio based on realistic expectations and solid fundamentals, you can approach an uncertain future with confidence. You may also avoid a lot of unnecessary pain along the way.

Elaine Longer, CFA, is President of Longer Investments Inc., an investment advisory company in Fayetteville registered with the SEC. For more information, visit www.longerinv.com.