Wednesday, October 31, 2007

Afraid Of Investing In The Stock Market?

I've noticed a some bloggers are losing their confidence when it comes to investing in the stock market. Even people who strongly advocated buying and holding index funds are now pulling out of the market themselves. While they may feel better in the short term, it is likely their portfolios will significantly underperform in the long term.

Here's the data from Dalbar, an investment research firm. They found that market timers in mutual funds lost an average 3.29% per year, resulting in an average investor annual return of 3.51% during a time when the S&P index returned 12.98% annualized. A net difference of -16.49% is quite a big penalty for trying to time the market.

However, I understand fully that staying invested is an intellectual and psychological decision. In the past, emotion usually prevailed, causing me to sell instead of staying invested. Here are some ways I have tried to conquer the emotional element:

Allocated a portion I felt comfortable to risk. I confess that I have not been fully invested in the stock market. Historically, most of the accounts we control (taxable and tax exempt) have been in fixed income investments, with a maximum of 30% allocated to stocks. Thus, a minority portion of my savings would participate in the stock market. During the great tech bull market, my overall portfolio didn't grow exponentially like most of my peers. However during the tech crash of 2000 to 2002, I didn't lose as much money either, which made me feel good.

The other portion I was willing to risk was the company retirement account since 100% was invested in company stock (unnamed to maintain my anonymity:-) for most of my career. Fortunately for us, my company stock has returned about 16% annually for the past 20 years, outperforming the 9.5% return by the S&P 500 index during the same time.

Invested a small portion in quality companies with potential for exponential growth. When I first started investing, I tried to win big with with every stock pick. I would try to find out of favor stocks that I thought were under valued. More often than not, I was wrong would lose money. In the eighties, I did not to invest in "darling" stocks such as Dell and Microsoft. As it turned out, $1000 invested in Dell or Microsoft would return $386,250 and $246,700 respectively by May, 2007. So now I try to find "high potential" stocks in which to invest a small portion of my portfolio. I have chosen three stocks for this category, Google, Amazon and General Electric and made them part of my personal core stock holdings.

I won't sell these stocks unless there is a significant deterioration of the company fundamentals. For example, I have stayed invested these stocks despite the volatility of that past few months.

Hired a good professional wealth manager. As noted above, the returns from my company retirement plan were exceptional because I was required to stay 100% invested in our company stock. Therefore, about three years ago, I hired a professional manager for 1/3 of our personal accounts. He designed an investment strategy and has kept the funds 95% invested in the stock market during that time. My running joke with my manager is "Keep me invested when I bail out in my own accounts." Although I do pay a asset based fee, the returns have been comparable to the S&P 500 index and higher than my fixed income returns, after fees.

For reference, I found an advisor who is committed to wealth preservation and growth strategies, and part of an advisor team that had a track record of over 20 years. I didn't want someone who was successful primarily due to a narrow sector (e.g. energy, gold or tech) focus. My main expectation is that our advisor will keep us invested in a divesified portfolio so that our returns, at a minimum, match the S&P 500 index over the long term.

Although I haven't done the calculation, I expect that the returns outside of my company retirement account have been below those of the S&P 500 index. However, I am not disappointed since the level of risk was acceptable and returns were offset by the company retirement plan which beat the market.

For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

Photo Credit: morgueFile.com, Jane M. Sawyer
This is not financial or investing advice. Please consult a professional advisor.
Copyright © 2007 Achievement Catalyst, LLC

2 comments:

hedge funds stragtegies said...

I don't fear to invest in stock. Take Warren buffett as example. His company is doing well all the time and have exceptional gain the past years. I agree sometimes the emotion rules when investing. Everyone knows one should buy low and sell high. It is the principal but when some unexpected news struck you, and everyone start selling their shares of particular company that have good fundamental backgrounds, you will start saying yourself did you make a good choice. if so why every one is selling it?! It is particular true before the IT bubble burst as you mentioned in 2000-2002. Everyone was buying it, it should be good!
But who knew that it was nothing than dreams!

So I do think a good EQ is essential to maintain a good money making financial portfolio after all!

Lissa said...

It's easy to make money in the market. If stocks go up, buy them,if stocks don't go up, don't buy! There is nothing to be afraid of. I also found a website that provides complete guidance on how to invest in the stock market. Get access to the website Hotstockideas for more details.