December 23, 2008

Financial Planning Notes – December 2008

Filed under: Uncategorized — MikeT @ 12:00 am

It has been a tough year for investing to say the least.  With 2008 nearing a close, major markets around the world have dropped 35 – 40+% this year (Source:  The steep decline in equity markets (publicly traded companies) has been broadly based leaving virtually nowhere to hide in terms of sectors or geographical areas.

Although some in the media may have you believe otherwise, this downturn is no different from any other in the past.  History has proven that the economy recovers after bad times, often led by a revival of equity markets.  Recovery takes time and patience.

It is natural to want to minimize losses in the short-run by moving out of equity investments and into cash.  The problem is timing the market, to get out early enough or back in before the upswing, is extremely difficult.  My belief is that past success in doing this is based mainly on luck.  Further, those choosing to time the market are potentially limiting their long-term return through missed opportunity.

The graph below shows the risk of not participating in the best performance days on the Canadian and U.S. markets from 1998 to 2007.  Moving from left to right, the first set of bars show the returns one would realize in the respective indexes if money was invested and held for 10 years.  The next set shows what would happen to returns if the investor removed money from the respective indexes and missed the 10 best days.  In the case of the Canadian index, the return would fall from an average annual return of 10% to only 5.7%, nearly losing 5%.  The remaining bars illustrate what happens if we remove additional best performance days for each index.

Staying Invested

Staying Invested

The point to take from this is investors can damage their portfolio’s long-term performance by temporarily moving out of equities during tough market conditions.  The best days on the market do not necessarily occur in consecutive strings, making it difficult to identify what opportunity has been missed.  Based on this, I believe keeping money invested in portfolios is the key to maximizing long-term returns.  Further, you may miss some great opportunities if you “wait for the market to recover” when adding new money to your investment portfolios.



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