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To
Your Wealth Michael
P. Haubrich, CFP Volatility
in the Stock Market
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I have been asked if the stock
market’s decline over the past couple of months is normal or can we expect
another return of a Tilt-A-Whirl bear market, spinning us back to the lows of
2002. While no one has yet to create a reliable crystal ball, we can look at
history along with some of the current factors injecting volatility into the
stock market for a better understanding of what we might expect. Before I discuss the current
market, I would like to review the fundamental concept of volatility as it
relates to investing in the stock market. As we all know there is risk
inherent with investing in stocks. Certainly, the last four years have
demonstrated the volatility and unpredictability of returns in the
short-term. During protracted bear
markets, such as the one we experienced from 2000 to 2003, declines of up to
50% are common. Protracted bear markets themselves are uncommon, typically
occurring only once in every 30 to 40 years. However, it’s important to note
that fluctuations are common even in bull market conditions. Over the last 70 years, the
S&P 500 Index, which is a good indicator for large company stocks, has
had an annual standard deviation of 20.21% with an average return of
10.4%. This means in a typical year,
we can expect returns to range by a high of 30% to a low of -10% two thirds
of the time. We accept this fluctuation in exchange for the reward of higher
average returns over the long-run
compared to other types of investments. We use diversification among
different investments, such as bonds and cash to reduce risk. Even with a balanced portfolio of 40% bonds
and 60% stocks, the standard deviation is 8.9%, which shows the added benefit
of diversification but also the likelihood of returns varying each year.
Our belief is that the current
volatility in the market is part of the normal investing cycle and not the
beginning of another major stock market downturn. This reasoning is based on
an objective comparison of today’s market environment compared with the
environment of the last four years: ·
Today we have strong
economic growth as evidenced by the increases in GDP compared to the declines
we experienced in 2001; ·
The corporate
scandals of 2002 are mostly behind us and no rational CEO would contemplate
“cooking the books” after seeing what has and continues to happen to the
offending executives; ·
New legislation and
regulations, such as Sarbanes-Oxley, further reduce the potential for
corporate malfeasance; ·
While we are engaged
in the on-going war against terrorism, no terrorist attacks have occurred on Many of the pundits on Wall Street
attribute the current market volatility to uncertainty as to the amount of an
interest rate increase to be expected from the Federal Reserve when they meet
at the end of June. Add to this the
geopolitical (event) risk in the Now is the time to exercise
discipline with your investments – having a plan and sticking to it. While market volatility provides
opportunity to pick up some bargains on the dips, be sure to maintain
appropriate investment allocation between cash, bonds and stocks consistent
with both your short- and long-term goals.
Before acting out on a significant change, be sure to consult your
advisor.
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