As our economy emerges from the worst recession since the Great Depression, some investors remain cautious while others have become rather enthused. Investors commonly look to the Dow Jones Industrial Average Index (the Dow) and/or the Standard & Poors 500 Index (the S&P) to gauge performance. The stock market is often measured by its periods of gains and losses. A “Bull Market” is widely recognized as an INCREASE of 20% or more from a previous market bottom, whereas a “Bear Market” is a DECREASE of 20% or more from its last peak. Since March of 2009, when the Dow fell on its “bear bottom” (please forgive the indulgent pun), the current Bull Market has lifted the Dow to over 15,500 (as of the time of this writing).

As the stock market reclaims previous record highs and sets new ones, no one should kid themselves . . . it isn’t going to be “different this time.” At some point, the current Bull Market will be replaced by a Bear Market. Then, that Bear Market will likely be replaced by another Bull Market, and so on and so forth. There have been 25 Bull Markets and 25 Bear Markets since 1929. The average Bull Market lasts 31 months and the average Bear Market lasts 10 months. As I mentioned earlier, the current Bull Market started in March of 2009, which means it is over four years in length. It is longer than the average, but still much shorter than the longest Bull Market in history, which started in December of 1987 and lasted about 12½ years (www.gold-eagle.com).

If you are investing for your future, or you are already drawing retirement income, it is important to understand these market cycles. As individuals, we can’t control the economy or the markets. We can, however, control how and where we invest. We can also educate ourselves on the common causes of investment losses:

 

1. Volatility and permanent losses are not the same. Volatility is a way of measuring how much an investment fluctuates in value. There is some truth to the saying, “it’s not a gain or loss until you sell it.” Fluctuations are normal and should be expected. A permanent loss, on the other hand, results from either selling an investment when it has dropped in value, or from an investment becoming worthless.

 

2. Investing in one stock can lead to a permanent loss. For example, let’s say you invested in a pharmaceutical company that developed a drug which lowered cholesterol. The medication showed great results and was prescribed and dispensed worldwide. Unfortunately, a few years later, the drug was linked to severe liver damage. Lawsuits followed. The company went bankrupt. Your investment became worthless.

 

3. Diversification can help reduce the risks associated with individual stocks. Instead of one pharmaceutical firm, this time you purchased a healthcare index fund that invested in many such companies. Now, if one of the companies went “belly-up,” your losses would be a lot less. Of course, it would also be prudent to take your diversification a step further, and invest in several different economic sectors. Holding a well-diversified portfolio can still result in temporary declines due to volatility and overall economic conditions, but you’ve significantly reduced the potential damage from one investment going sour.

 

4. Investing for shorter periods can increase the odds of loss. If we look at the history of the S&P 500 Index from 1926 to 2012, 10-year holding periods produced a negative return just 16% of the time, while 1-year holding periods resulted in a loss 32% of the time (www.allfinancialmatters.com). While “prior performance may not be indicative of future results,” I would argue that a low-cost, diversified portfolio, held for long time periods, has a better chance of producing positive results than a short term investment or, even worse, trying to time the market.

 

5. Dollar-cost-averaging is a popular investment strategy that can produce a lower average purchase price over time (you invest a set dollar amount each month and, as a result, buy more when the price is lower, and less when the price is higher). Trying to reverse the process for retirement income, however, can lead to a series of permanent losses (you may have to sell more of your investments when the price goes down in order to get the same amount of income).  Reverse dollar-cost-averaging can produce permanent losses, so I call it, “Dollar-Cost-Ravaging.” Don’t do it.

 

Bull and Bear Markets will come and go, but the key to smart investing (which can lead to a successful retirement) resides mostly in avoiding mistakes. Don’t concentrate your money in just a few stocks; maintain a diversified portfolio; keep your investment fees low; and draw your retirement income from conservative investments or financial vehicles with contractual guarantees of income. While prior performance varies, taking prudent steps, like these, may actually be indicative of your future results!

 

David D. Holland, a CERTIFIED FINANCIAL PLANNER™ practitioner, hosts a weekday radio show. He has also authored two books in his Confessions of a Financial Planner series. Holland offers investment advice through Holland Advisory Services, Inc., a registered investment adviser in Ormond Beach. He can be contacted at (386) 671-7526. Email your financial questions to info@DavidHolland.com.