Marvin Appel, MD., PhD & Brian Hufford, CPA, CFP
Many investors' long-term commitment to the stock market has not been profitable. According to Dalbar Associates, from 1984 to 2000 the average equity investor realized an annual return of only 5.3 percent, compared to 16.3 percent for the S&P 500 Index during the same period. Income investors did no better — bond investments earned an average of 6.1 percent per year, compared to 10.3 percent for the Lehman Aggregate Bond Index.
Some mutual fund companies interpret these results as proof that market timing strategies are ineffective, since, over the time period studied, mutual fund investors would have done better to stay in index funds continuously. We suggest the opposite: The results show that investors who fail to develop a market timing discipline ultimately make ad hoc decisions that are detrimental.
Why have so many fared so poorly? The mutual fund industry has exacerbated the problem by promoting "hot" products at inopportune times. For example, the Steele Mutual Fund Expert Data Base lists 324 information technology funds. Of these, more than two-thirds were launched after that sector had already peaked. Because small cap value funds badly lagged technology funds in 1998 to 1999, barely a quarter of small cap value funds were launched over the same period, even though these funds were far more successful from 2000 to 2002. However, small cap value funds are gaining momentum. In 2002, 20 new small cap value funds were launched, compared with only four technology funds.
When making stock purchases, it's important to allow sufficient time to evaluate the costs and benefits. Making an investment should never be an "emergency." Avoid following the recommendation of any advisor who tells you otherwise.
The best time to consider selling an investment is before a bear market hits. Suppose you earn $100,000 per year and have amassed $700,000 in retirement plan assets. A 15 percent decline would wipe out an entire year's earnings if you were invested only in stocks. Could you really stand by and stay the course, or would you panic and sell? If you bail out, how would you know when to get back into stocks?
These are important questions for anyone whose savings are significant relative to income. There is no panacea for bear markets, but you can protect yourself with some simple strategies to reduce the likelihood of extreme moves in your portfolio.
• Long-term investors should keep at least 25 percent of assets in income investments (money markets, CD's, bonds etc.). Conversely, bond investors should keep 25 percent of their assets in diversified stock market investments such as low-cost S&P 500 index funds.
• Know in advance how much you can afford to lose. When losses reach the "danger point," move into cash. A general rule is that the further you are from retirement, the greater the amount of loss you can tolerate and recoup.
• Emphasize low-volatility investments. Only 20 percent or less of your portfolio should be in mutual funds more volatile than the S&P 500. "Buy and hold" bond fund investors should stick with high-grade, intermediate term bond funds.
• Don't chase new fads. Unless you have particular insight, it is best to stick with mutual funds with a proven track record.
• Rebalance your portfolio at least annually. This could mean redeeming part of your more successful investments and adding positions to your less successful investments.
The first step to investment success is to set up a plan you can realistically follow. Blithely buying and holding until market conditions become unbearable rarely is profitable. Invest in relatively stable, time-tested mutual funds and formulate an exit strategy in advance. These basic strategies will allow you to keep an eye on your investments and stay on track towards a secure retirement.
Dr. Marvin Appel is CEO of Appel Asset Management. He holds a degree in biochemical sciences from Harvard College and earned his MD in 1991. He is coauthor of Systems and Forecasts. Contact him at (516) 487-7146 or [email protected]. Brian C. Hufford, CPA, CFP, is president of Hufford Investment Advisory Programs, LLC, and Hufford Financial Advisors, companies dedicated solely to helping dentists secure solid financial planning and safe investment strategies. He can be reached at (317) 848-4987.
