Dealing with Volatility

Many of us saw negative portfolio returns over the last couple of months of 2007, and the first month of the New Year is shaping up to be a down month, as well.

Monthly returns are really just noise like the financial pundits who try to explain why the market went up or down on any given day and predict what tomorrow will bring. Believing them or acting on short-term market results is usually done at great peril to one’s financial well being.

As much as we encourage investors to keep a long-term perspective and not look at monthly returns, we know a lot of you do take a peek at those monthly numbers.

We also know that investor psychology being what it is makes two months of negative performance tolerable (barely), but three months seems close to the threshold of pain for many.

January is very likely to be that crossing point month.

How will you react?

It may seem like a broken record, but having a long-term perspective is the antidote.

If you look at the performance of the underlying asset classes that make up our globally diversified Asset Class portfolio from 1973 to 2006 the performance with all fees netted out is 14.90%. Great performance by almost any measure and a return that will enable most of us to well meet our financial goals and objectives.

Studying the monthly returns of this same high performing, diversified portfolio over these same 33 years, though, you would see broad swings that would look like a not particularly healthy EKG read-out. This, again, is noise. It is the smoothing out of these numbers through time that provides the double-digit return the portfolio has provided.

Return without risk can be had. The yield, however, is likely to be in the very low single digits and it will come from short-term bonds. The equity markets only provide higher historical returns because there is risk. Diversification and time puts the odds in the court of the successful investor.

But what about those short-term numbers you may be looking at?

Well, going back and looking at the S&P 500© we find that in 1990 there were five months of back-to-back negative returns. From June through October 1990, the S&P 500© had a return of -14.69%.

For the four months prior to this period the index had a positive return of 11.26%, and the seven months following October 1990 the S&P 500© earned investors a 31.04% return.

If an investor had reacted to the first two, three or even five months of negative statements look at what they would have missed? Seven great months.

Being invested from February 1990 through these five difficult months and then earning the return of the next seven high performing months would have provided a total return of 24.38%.

Will our current downturn in the market be three, four, five or more months? No one can say for sure.

The market does cleanse itself and has always sought new highs.

The best advice remains the same: believe in efficient markets and capitalism, and maintain a long-term perspective.