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Question Of The Month Febuary, 2009
Which Would
You Choose: Something That Is Guaranteed Something That Is Probable
Something That Is Possible?
If you were looking for an
efficient way to reach a goal ---- lose some weight, become more efficient
in your profession, obtain a college graduate degree, become a better
parent, learn how to garden ---- how would you go about accomplishing your
task?
You could do some research and
look at --- try a number of approaches --- some that might work, some that
might not --- some you would quickly dispose of --- some that have
possibilities --- some that dont.
Paul Merriman of FundAdvice.com
provides an interesting perspective when he proposes looking at investing
from three possible choices.
You Have Three Choices When You
Invest.
Choice #1: Some things are
guaranteed ----------Conservative
Guarantee: Assurance that
something will be done as specified (Webster Dictionary).
The return you get on a
certificate of deposit or a Treasury security is one example. Investors who
require certainty can get it, but at a very costly price. When the bank
guarantees what it will pay on a CD, it assumes all the risk. In return for
that, the bank promises to pay a very low interest rate.
Choice #2: Some Things Are
Probable Though Not Guaranteed ------Moderately Conservative
Probable: Likely to be or become
true or real (Webster Dictionary). One example is the notion that stock
funds will outperform bond funds in the future. There will always be periods
in which the opposite occurs. But if history is any guide, its more likely
than not --- that over long periods that stock funds will outperform bond
funds. Research indicates that over long periods of time, stocks have
returned about 6 - 7% above the rate of inflation bonds about 2 3%.
Choice #3: Some Things Are
Possible, Although Not Probable ---------- Aggressive
Possible: Being something that
may or may not occur (Webster Dictionary). One example is that the stock you read
about or that is recommended to you by somebody you know will turn out to be
the next Microsoft. In fact there is probably some relatively small,
relatively new company on the market right now that, 10 or 20 years from
now, will be an industrial giant. But out of 5,000 or so possible
candidates, will you be lucky enough to spot that one future gem.
How should you make you
investment decisions? Some experts say that Choice #2 is the best one
-Some Things Are Probable Though Not Guaranteed. Make your investment
decisions based on what is probable, not what is possible. From 1995
through 1999, the Standard and Poors 500 Index compounded at a rate of 28.5%
a year. Plenty of investors concluded that successful investing was pretty
easy --- returns of 75% were possible. However, the bear market of 2000
2003 showed us that 75% losses were equally possible.
We have data from three quarters
of a century (75 years) of history to show us what is probable.
According to Ibbotson Associates, a leading authority on asset allocation,
large-company stocks returned 10.4%, compounded annually from 1926 through
2005. Small-company stocks provided a return of 12.4 percent. This look at
reality --- and not the flash-in-the-pan excitement of a bull market----that
should be the basis of your planning. When you invest in that manner, you
will have probability working for you, not against you
Jeremy Siegel, Professor of
Finance at Wharton School at the University of Pennsylvania, and author of
"Stocks for the Long Run" (1998), shows us what is probable. He presents a
thorough analysis of stock market data showing that stocks returned about 7%
above inflation for the past two hundred years, and that for twenty year
time frames, stocks outperformed bonds over 90% of the time --- Some Things
Are Probable.
What
does history tell us about what is possible and what is probable?
When you take a look at market
total returns from 1926 2005, you will see what is possible and what is
probable when you invest in the market. First, what is possible --- The
Best Year --- in 1935, stocks returned 60.0%, bonds returned 42.1% and
T-Bills returned 14.0%. But, you will also find that it is also possible to
lose big time in the worst year --- stocks lost 41.1 in 1931 --- bonds lost
8.7% in 1999 and T-Bills had a return of 0.0%. How about average over that
period--- stocks returns 12.7% ---bonds returned 5.8% and T-Bills returned
3.8%. -
Quote
Of The Month
History tells us that stocks have
typically performed very well when the country comes out of a recession.
Since 1953, there have been nine recessions, lasting an average of 11
months. On average, the stock market (based on returns of the Standard &
Poors 500 Index) gained 36 percent from the low point of the recession to
six months after the recession ended.
The current recession is in its 13th month, already longer than average.
While we can predict neither the length of this recession nor the short-term
movement of stock prices, stocks have risen from their lows. Since reaching
a low on November 20, 2008, the S&P 500 increased 15.6 percent through
December 29,2008. FundAdvice.com 12/30/2008
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