Coping with Fear
September 18, 2008
Anyone who has tuned into the news recently has seen some scary financial headlines:
- September 15th's 504-point drop in the Dow Jones Industrial Average (4.4%) was the biggest decline since September 17, 2001.
- Year to date through September 17, 2008 the S&P 500 Index has lost 20.09% of its value.
- Freddie Mac and Fannie Mae will be taken over by the federal government.
- Lehman Brothers files for bankruptcy, Merrill Lynch is sold to Bank of America, and the government bails out AIG, largely due to billions of dollars in bad investments made in subprime mortgages and real estate.
- 24,000 employees of Lehman Brothers have seen an estimated $10 billion in personal wealth evaporate as the value of shares collapsed.
News like this makes even the most calm investor think about whether "this time is different" and wonder if it's time to abandon stock markets altogether and bury the cash in the backyard. So let's look at some other facts:
- Monday's decline ranks fourteenth worst among all trading sessions since January 1950. First place goes to October 19, 1987 drop of 20.47%-and since then, the S&P has gained over 414%.
- For well-diversified investors, the financial damage associated with the four firms mentioned above (AIG, Fannie Mae, Freddie Mac, and Lehman Brothers Holdings) has been minor; in aggregate, they represented less than 1% of a diversified US equity portfolio on May 31, 2008, and even less for a global portfolio.
- History offers abundant evidence that market economies are resilient: they have survived world wars and conflicts; presidential assassinations and elections; manias and panics; inflation, deflation and stagnation; and more.
- Bond funds owning debt securities backed by Fannie or Freddie gained from the proposed government takeover, resulting in a more positive outlook in the mortgage market.
- Schwab and Vanguard are financially solid and don't hold any Lehman Brothers securities in their money market funds.
The reality is, all of the news just reinforces our long-held trust in the
importance of diversification. And we've got great company-everyone from
pension fund managers to the Harvard Endowment Fund to Nobel Prize Laureates.
And let us assure you, this is not just what we do for a living, this is
how we personally invest our own money. Each of us has a different asset
allocation, of course, as do each of our clients. But we buy the same funds
that we recommend to you, and use the
same guidelines to manage and rebalance our investments. So to quote Bill
Clinton, "we feel your pain!"
The key to being a successful investor is having the discipline and emotional strength to stay invested in markets even when they deliver gut-wrenching drops like these. In fact, many studies have shown that the "best" thing to do when markets are falling is to dollar-cost average in, since you are buying shares at a lower price (like stocking up on mayonnaise when it goes on sale). But that can be too hard for some to do, as it is so contrary to our emotions.
Our emotions and our fears also prompt us to look for a better solution-we feel a need to do something with our portfolios instead of just standing by. The financial industry and media encourage this, because that's how they sell magazines, newsletters and investments. They also tend to emphasize the negative: they write about the plane that crashes instead of the thousands that land safely. They say "the situation could get a lot worse" when the situation could get a lot better, too. We never know what's going to happen in the future.
So how can you cope with your fear, if you have some? Ignore the things you can't control (the markets) and focus on the things you can: spend less, save more, keep a good cash cushion on hand. It may be appropriate for some people to set up a home equity line of credit, even if there is no current need for the cash. Others may benefit from refinancing their mortgage if rates have dropped enough from their original one.
One client's solution: "I guess I just won't open the quarterly fund performance statements when they come in the near future!!" Turn off the 24 hour news channel, listen to music, read a book, take a walk, call a friend. Remember you're a long term investor, that you have a plan that is designed to make your money live as long as you do, so trust the plan. And call us.
Let us know if you have any questions or concerns, or would like to get together for a meeting any time soon. The economic and investment news has been dismal and is likely to continue that way for some time. We continue to have faith in diversification and will keep a close eye on your portfolio.
Deborah L. Thomas, JD, CFP®
Stephen W. Hewitt, JD, CFP®
Benjamin E. Gilbert, CFP®
Jessica M. Howe