Planner's pulpit
Responding to market mayhem
Posted on November 5, 2007 by Rev. John F. Harrison, CFP®
It was all over the headlines. Last Thursday, the Dow Jones Industrial Average dropped 362 points. That's a lot of downward movement for one day. But what does this volatility mean, and what should you do about it?
Meaning requires a context. Consider: The higher the stock market indices climb, the less significant a 360-point move becomes. On October 19, 1987, the Dow dropped 508 points to close at 1739. That was a 22.6% drop. Today, with the Dow around 13,500 the same 508-point drop would represent only around a 3% loss. While shouting the number of points the market rose or fell, the headlines rarely mention whether the percentage change warrants all the shouting.
Another point to keep in mind is that your own investment portfolio probably does not exactly mirror the Dow Jones Industrial Average. After all, the Dow is made up of just 35 stocks. Most investors own mutual funds, and are therefore far more diversified than that. Sometimes the broader stock market moves in sync with the Dow (it did last Thursday), and sometimes it doesn't. But don't automatically assume that whatever the Dow did is what your portfolio did.
Now, let's assume that your personal investment portfolio was in fact off 3% as of the close of business last Thursday, just like the Dow. How should you feel about that? Again, we need context for the decline. The Dow was off for the week (-1.49%) and for the month (-3.06%). But it was up year-to-date (+11.04%). For the rolling twelve months, it was up 15.68% and had an average annualized return of 12.31% for the past 5 years, all according to Morningstar on 11/02/07. Is Thursday's drop worrisome in view of that? That depends.
Let's say the investment in question is your retirement portfolio. If you are ten or more years away from retiring and are still adding to the portfolio, it's probably safe to see the drop as a buying opportunity. If you're not done buying yet, buying shares at a discount is a good thing. Ten years from now, you'll have no memory of last Thursday's dip. It simply won't matter.
But what if retirement is only 2 years away? What if you're already retired, and worried about preserving the nest egg you live on? What if you are just temperamentally unsuited to market dips, and hearing about them makes you hyperventilate? Then you need to consider investments that don't expose you to the risk of the dips.
That doesn't mean you have to go to all cash, fixed annuities, and the like. One item you might investigate is PPNs - Principle Protected Notes. They can be structured as bank CDs, meaning they have FDIC insurance for your principle. But unlike typical CDs, these are linked to one or more stock market indices. At the maturity of the PPN, you get the index return if it's positive. If it's negative, you get your principle back, so there is no risk of loss. Of course, in an inflationary environment, your principal has less buying power next year than it does now. Some PPNs offer minimum rates of interest, thus guaranteeing some return in excess of principle. Many impose some kind of cap on the upside potential. Terms vary widely, so look at several.
PPNs offer one solution for risk-averse people who know they need the growth potential of stock market exposure, but can't stomach the ups and downs. There are several others. The key point is this: If market volatility gives you the willies, there is something you can do besides worry.
Responding to market mayhem
Posted on November 5, 2007 by Rev. John F. Harrison, CFP®
It was all over the headlines. Last Thursday, the Dow Jones Industrial Average dropped 362 points. That's a lot of downward movement for one day. But what does this volatility mean, and what should you do about it?
Meaning requires a context. Consider: The higher the stock market indices climb, the less significant a 360-point move becomes. On October 19, 1987, the Dow dropped 508 points to close at 1739. That was a 22.6% drop. Today, with the Dow around 13,500 the same 508-point drop would represent only around a 3% loss. While shouting the number of points the market rose or fell, the headlines rarely mention whether the percentage change warrants all the shouting.
Another point to keep in mind is that your own investment portfolio probably does not exactly mirror the Dow Jones Industrial Average. After all, the Dow is made up of just 35 stocks. Most investors own mutual funds, and are therefore far more diversified than that. Sometimes the broader stock market moves in sync with the Dow (it did last Thursday), and sometimes it doesn't. But don't automatically assume that whatever the Dow did is what your portfolio did.
Now, let's assume that your personal investment portfolio was in fact off 3% as of the close of business last Thursday, just like the Dow. How should you feel about that? Again, we need context for the decline. The Dow was off for the week (-1.49%) and for the month (-3.06%). But it was up year-to-date (+11.04%). For the rolling twelve months, it was up 15.68% and had an average annualized return of 12.31% for the past 5 years, all according to Morningstar on 11/02/07. Is Thursday's drop worrisome in view of that? That depends.
Let's say the investment in question is your retirement portfolio. If you are ten or more years away from retiring and are still adding to the portfolio, it's probably safe to see the drop as a buying opportunity. If you're not done buying yet, buying shares at a discount is a good thing. Ten years from now, you'll have no memory of last Thursday's dip. It simply won't matter.
But what if retirement is only 2 years away? What if you're already retired, and worried about preserving the nest egg you live on? What if you are just temperamentally unsuited to market dips, and hearing about them makes you hyperventilate? Then you need to consider investments that don't expose you to the risk of the dips.
That doesn't mean you have to go to all cash, fixed annuities, and the like. One item you might investigate is PPNs - Principle Protected Notes. They can be structured as bank CDs, meaning they have FDIC insurance for your principle. But unlike typical CDs, these are linked to one or more stock market indices. At the maturity of the PPN, you get the index return if it's positive. If it's negative, you get your principle back, so there is no risk of loss. Of course, in an inflationary environment, your principal has less buying power next year than it does now. Some PPNs offer minimum rates of interest, thus guaranteeing some return in excess of principle. Many impose some kind of cap on the upside potential. Terms vary widely, so look at several.
PPNs offer one solution for risk-averse people who know they need the growth potential of stock market exposure, but can't stomach the ups and downs. There are several others. The key point is this: If market volatility gives you the willies, there is something you can do besides worry.
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Responding to market mayhem
Is there a topic you'd like us to talk about? Email your suggestions or questions to us.
Making Lemonade
Health Savings Accounts
REMNDR
News Flash
How bad is it?
It's no secret
Responding to market mayhem
Is there a topic you'd like us to talk about? Email your suggestions or questions to us.