The life of a contractor requires taking breaks from time to time. Each day it is critical to take a one-hour break to get away from the bidding and the day-to-day frenzy. It’s also a good idea to take a break at least once a year so that you’re able to refresh and replenish. But when it comes to financial planning, is it a good idea to take a break or time out? Not so. If you’ve been investing over the past decade, you probably have good reason to be confused about the stock market’s performance. After all, from January 1995 through December 1999, the S & P 500 Index, an unmanaged index that cannot be invested into directly, gained an average of nearly 29 percent per year. But from January 2000 through December 2002, that same index dropped, on average, more than 14 percent per year. The market rallied in 2003, but results have been mixed in 2004. As stocks repeatedly move up and down, what’s an investor to do?
First, you need to realize that, over the short term, the stock market has always been volatile. But over the long term, the stock market has always trended up. From the beginning of 1926 through the end of 2003, stocks, as measured by the S & P 500, showed a compound annual growth rate of 10.4 percent, according to the market research firm Ibbotson Associates. (Keep in mind, though, that past performance does not assure future results.)
Of course, your investment horizon may be a bit shorter than 77 years. So, as you invest in stocks, you may wonder if there isn’t some way to duck out of the market during “down” times. Theoretically, it’s a great idea; but in practical terms, it’s not really possible. Why? Because no one—not even the most widely known market “experts” —can accurately predict when a down market will turn up and when a strong market will head south.
Consequently, if you take a break from investing, you could miss out on some good opportunities for gains.
Want proof? Let’s look at some numbers. Suppose you began investing in the stock market (as represented by the S & P 500) at the end of 1953. If you had stayed invested until the end of 2003, you would have earned a 7.9 percent return. But suppose, along the way, you had pulled out of the market for short periods of time. If you missed just the market’s top ten days during that 50-year period — just 10 days — your return would have shrunk to 6.74 percent. And if you missed the top 40 days, your return would have eroded to 4.25 percent. Want to see a shorter time frame? Look at the 10-year period from the beginning of 1993 through the end of 2003. If you had stayed invested the entire time, you would have received a 9.07 percent return. But if you missed the top 10 days, you would have just gotten a 4.05 percent return — and if you were out for the top 40 days, your return would have been a negative 5.81 percent. (All these returns exclude reinvested dividends and transaction or commission costs.)
Clearly, it can pay to stay invested. Still, all the long-term numbers in the world probably won’t make you feel better if you’re dismayed over your monthly brokerage statements. How can you ease this type of discomfort?
You can’t control market volatility. But you can blunt its impact by diversifying your investment dollars across a wide range of assets — stocks, bonds, government securities and certificates of deposit. While diversification doesn’t eliminate market risks, the more diversified you are, the less susceptible your portfolio will be to market downturns that hit one asset class particularly hard.
And there’s one more thing you can do: Keep your focus on the future and your long-term goals. Most contractors remember the values they had to practice to make their business successful today. It took a really focused effort. The same applies not just to investing but life. That’s not always easy. It takes discipline and real commitment to keep investing during turbulent times — but the ultimate reward may well be worth the effort.