War in the Middle East, a depressed economy at home, a three-year bear market: what should investors do in these highly uncertain times? Some investors jump out of stocks and head for the “safety” of fixed income investments or temporarily stop making investment purchases. Others hang on to their investments but agonize over fears of capital loss. These are probably the wrong choices for most investors. They hurt themselves by focusing on the uncertainty caused by current events.
People often forget two important facts about investing. First, uncertainty is always present in the investment markets. We are never sure about the outcome of the day-to-day events that cloud our horizons. Second, there are no risk-free investments. When stocks are declining many investors focus only on the risk of stock volatility. They forget about another serious long-term risk—INFLATION.
To understand how uncertainty and inflation risk affect different investors, consider two situations: a younger working investor who has 20 years to go until retirement, and a newly-retired investor who needs to use a portion of his portfolio each year to supplement other retirement income. Let’s examine how each of these investors deals with uncertainty and inflation.
- Uncertainty is normal
Any investor waiting for outcomes to become certain before investing will have a long wait indeed. As old uncertainties fade, new ones will pop up. The future is never predictable and we can never know how current events and trends will play out until after the fact.
Consider the worldwide debt crisis of the late 1990s that started in Thailand, spread to Russia, caused a major U.S. hedge fund to go under, and threatened some of the world’s largest banks. The consequences of those events were far more limited than predicted. The stock market continued to roar ahead for several years, culminating in huge gains in 1999.
Jump ahead to January 2000. The predicted collapse of the world’s computer systems due to the Y2K bug did not occur, and confident investors poured money into a soaring stock market. Precisely at the time when the average investor was most confident about the stock market, it had already entered one of the worst and longest bear markets of all time.
So how does a younger, working investor handle this uncertainty? He keeps investing—knowing that time is on his side. He can be fairly confident that—in 20 years or more—all of today’s adversities will have faded away and that economic growth will have propelled stock prices, and his portfolio, to new highs.
The older investor handles this uncertainty in a slightly different manner: he remains diversified enough and keeps enough liquid reserves to carry him through long periods of market decline. He doesn’t risk putting money into stocks that he may have to spend within the next five years. This type of diversification gives him a good chance of withstanding even the longest of bear markets without realized losses.
- Inflation: The hidden threat
Many investors view short-term price declines with horror yet forget that the real threat to their wealth is long-term inflation. Over 20 years an inflation rate of just 3% can reduce the purchasing power of $100,000 to the equivalent of $54,380.
This is a serious threat to the younger investor. He needs real growth after inflation in order to build up a retirement fund. One proven way to keep up is to participate in economic growth through direct investment in business or indirect business investment via the stock market.
The newly retired investor also has to deal with inflation. A healthy retiree—who will live for 20 or more years after retirement—will see the value of a fixed pension decline sharply. He can offset the damage done to his income by keeping a portion of his portfolio in stocks. They have the potential to beat inflation over the long haul and provide extra income.
Now, I need to shift gears and discuss some business issues. In a recent email that I sent to all of my clients, I discussed the process of transforming my workplace into a “paperless office.” I have finished upgrading all of my computer hardware and software, but I am still in the process of scanning all of my client and business documents into “electronic files.” I expect to complete this process by the end of the summer. Please note that my fax number has changed to (484) 229-0202.
In order to comply with the provisions of the Gramm-Leach-Bliley Act, I am enclosing a copy of KFP’s Privacy Statement for your review. The Privacy Act requires that I deliver this to every client on an annual basis. In addition, as a Registered Investment Advisor, Keystone Financial Planning is required by state regulators to offer you a copy of Part II of Form ADV. The Form ADV is KFP’s registration with the Pennsylvania Securities Commission. If you would like a copy of Form ADV Part II, you may download it by going to the “Regulatory Compliance” page on KFP’s website (www.KeystoneFP.com). Please feel free to call me if you would like a copy mailed to you.
Thank you for your trust and confidence. I am enclosing a few of my updated business cards for you to share with your friends. I always appreciate your referrals. Please let me know what I can do to improve the quality and value of my services to you.
About Christopher Jones
Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.