Written by:

Frank Sisc, CPA, PFS, 30 Mill Road, New Rochelle, NY 10804

Home office - 914.740.4422, Cell - 914.589.1013; Email – ideasmoney@aol.com

www.LifeAndMoney.com

(Word count =   1,288 words plus 61 words for About the Author)

As I'm writing this column on August 28, 2007, the stock market indexes are declining significantly.   The Dow is down 280 points, or 2.1% to 13,041 and the S&P 500, and the Nasdaq and Russell 2000 are falling even more.   I'm online reading the pundits' explanations.   Subprime credit problems spreading.    Housing market worse than feared.   Fed Reserve officials worried about worsening economy.   Markets overseas frightened about American market woes.   Tonight I will turn on television and hear proclamations from some experts that it's the right time to sell and from others it's the right time to buy.   The markets have been volatile lately, and possibly even more so in the future.   I'm urging you to pause, review your situation and to be realistic with yourself and then act responsibly.

Let's say you are a person in her forties or fifties, married with children in college, and with a large mortgage on your house.   Your income, along with that of your husband, are good, but you don't seem to be able to save anything beyond the money going into your 401k and 403b plans.   Or let's imagine a similar situation for another couple except the children are out of college, becoming financially independent, but one spouse's financial situation is very tenuous.   His business (or his job) is in an industry undergoing a lot of change and it looks like income will fall in the near future, taking possibly years to recover.  

Should these people be invested in the stock market?   Based on this information, I would say no, unless they can demonstrate all of the following three factors: (1) that they understand that investments in the stock market can decline very significantly over long periods of time and (2) that they realize they may need to sell these investments in order to raise money to cover expenses and (3) that they are sure that they will be able to emotionally handle large and/or long erosions in their investments.   As a financial advisor for over 30 years, I have found the large majority of people cannot handle all three factors and end up selling during lower periods, and buying back during higher periods, no matter how smart they are.    Their emotions rule over their intentions.   Furthermore, there is a clear historical record that the equities markets have undergone long protracted bear market cycles.   One example is the period from 1966 to 1981, as it took 15 years for the S&P to recover its previous high. Regarding other markets, an article in the New York Times on 8/11/07 stated that both the Nasdaq and Japanese Nikkei 225 were once great performers at the end of the 1980s and 1990s, respectively, but both are now lower than when they were the stars.  

Don't forget that once down it is tougher to go up.   Here's a simple example.   You have $100,000 invested and over two years it lost 40% and fell to $60,000.   In order for the $60,000 to climb back to $100,000, it has to grow by $40,000 and that is 66.7% ($40,000 divided by $60,000), which is much more than 40%.   Declines are hard to make up.   Big and long declines are even harder.

If serious declines do occur, many baby boomers hoping to retire in the next few years may find themselves unable to do so.   Worse yet, many retirees already drawing down on their investments to cover expenses may find themselves running out of money, forcing them to sell their homes or dramatically curtail their lifestyle.

An article called "Equities in Retirement? Not So Fast" in the August 2007 issue of "Boomer Market Advisor" gave the following example of the devastating effects of a declining stock market in the early stages of retirement.   The assumed couple had just retired with a $2 million portfolio, planning for $130,000 for living expenses.   For the next 14 years, the portfolio earned an 8% return, but lost 10 percent in years 15 and 16.    At the end of year 16, the couple has $1.96 million. And if their portfolio resumed earning 8% they will have $2.3 million by year 25.   Pretty good.   The late losses did not terribly affect their assets or income.   But what happens if they lose 10% in the first and second years, and then get 8% for the next 14 years? The investment portfolio would have gone down from $2 million to $884,000, assuming the same $130,000 annual distributions.   Moreover, even if the returns continued at 8%, the portfolio will be completely gone by year 27.   That illustrates the significant difference caused by early losses in the portfolio.   Even if your own figures are different, the same concept may apply.

Over the years, the people I've met who have done poorly in equity-related investments far outnumber the people who have done well.   One reason is having too much of their investments subject to declines along with poor timing in the market, including selling at the wrong time.   Another reason is getting caught up in the mania and buying at highs, like during the dot com era.   One factor I found to be very helpful in minimizing these mistakes is getting an investment that has some degree of principal protection.   For example, I got many clients involved in a mutual fund years ago that mirrored the performance of the S&P 500 index, but it had a very special protective provision that I believed was well worth the 3% upfront sales charge.   At the end of 10 years from the date of the original investment, if the index was lower than at the beginning, then the investment company refunded the investor the difference.   The protection was a primary reason why many people did not sell out of that particular mutual fund when market cycles turned down, as they did other funds, and they reaped subsequent gains when the market cycle turned back up.   That particular investment is no longer available to new investors but there are other alternatives.

Although it may turn out that the next several months or few years bring about good gains in the stock market, is it really worth the risk to your financial health of taking the roller coaster?   Think about this.   It's well known that the average annual return on stocks (or mutual funds of stocks) based on the S&P 500 index is about 10%.    But recent studies show that the actual average annual return realized by most investors is much less.   Only about 4% or 5% because many investors make poor timing decisions.   Another way to look at the market performance is that if the long-term 10% is an average, and you know there are many big investors and insiders making 20% or more, then isn't it logical that the realized average for most of us regular investors must be less than 10% to make the average of the entire market be 10%.   Finally, even if you are able to a long-term 10%, is it worth jeopardizing your financial security?  

I'm not saying that non-guaranteed investments are not suitable in many situations for many people.   But probably not for the hypothetical couples I mentioned.   Or for seniors on a fixed-income.   Or for people without adequate life insurance, disability insurance or long-term care insurance.   Or people facing the possible catastrophic effects of a long-term illness. Or small business owners in erratic industries.   Or employees with uncertain futures.   You get my point?    If you feel you must be in the stock market or want to phase-out of it slowly, perhaps as one protective step you should check out the one-year FDIC insured market-linked certificates of deposit, for which at least your principal, not your earnings, are guaranteed.   Wouldn't that be more realistic and responsible for you?

About the author:

Frank Sisco is a CPA and Personal Financial Specialist and writes on topics related to life and money.   You can contact Frank by email at ideasmoney@aol.com or by phone at 914.589.1013 in order to express your opinion about this article or to obtain copies of prior articles.   He resides in New Rochelle, NY with his wife and daughter.