The More Things Change ... The More They (Should) Stay the Same

by Jay Braun

With all of the ups and downs in the financial markets these days, it's hard for investors to know what to do and when. Confusion often reigns.

A case in point: According to the Hewitt 401(k) Index, large amounts of money were transferred out of money market and guaranteed investments during February 2000. At the same time, large amounts of money were transferred into small U.S. and international stock investments. This, of course, was just before the stock market took a precipitous drop.

In February of 2003, almost the exact opposite occurred: A large amount of money was transferred out of stocks and into money markets and guaranteed investments. The Standard & Poor's (S&P) 500 then went on to post a gain of almost 30% for 2003.

How to respond to change?

Changes in financial markets often are extreme and usually unexpected. During market declines, investors can be left with feelings of helplessness. With uncertainties in such great abundance, and with moves in financial markets so dynamic, what should be done in response to great change?

Should investors react to what happens? Should they anticipate and act before any changes? Should they be on the sidelines with their assets under a mattress?

Let's take a look at all three of these approaches:

Reacting to what happens

As captured in the Hewitt 401(k) Index, individual investors often deal with changes in markets by reacting in ways that are counter to their best interests. The stock market suddenly declines, and people react by selling their stock investments. The market moves sharply higher, and people fear they may miss out on a good thing. So after some delay, they buy stocks.

That kind of buying usually reaches a crescendo very near market peaks. Translation: Many investors buy high and sell low.

Anticipating and acting

Conversely, some investors try to anticipate the movements of financial markets by attempting to get in at the lows and out at the peaks. This is the ideal strategy for successful investing … if you happen to know in advance where interest rates are headed, what unemployment will look like in the future, who will win the next election, or any other number of things that could shape the direction of the market.

But changes in markets and the economy are nearly impossible to anticipate by mere mortals, so market timing is clearly best left to the clairvoyant among us.

Sitting on the sidelines

Others sit on the sidelines with cash in their pockets, thereby avoiding the pain that is often associated with market volatility. For investors who need cash for immediate living expenses, holding some cash or cash equivalents--such as money market accounts, share certificates/certificates of deposit (CDs), or savings accounts--may be a good idea.

But holding only cash or cash equivalents usually provides small long-term returns after inflation, compared with more aggressive investments. Inflation is the chief enemy of long-term investors, so holding investments that historically have outpaced inflation usually makes sense, regardless of the current market environment.

So, if none of these options is viable, what should you do?

Implement a plan

You need to start with investment planning basics. You must have an understanding of where you want to be and when, and implement a plan that will help get you there. Then you should develop a sensible investment plan based on those goals and your tolerance for short-term volatility.

Make sure your plan is properly diversified--and stick with it. The well-thought-out plan is of no value if you don't maintain it. Indeed, the more things change, the more some things should stay the same.

Jay Braun is an investment marketing analyst for MEMBERS Capital Advisors, the registered investment adviser of CUNA Mutual Group that provides professional management as the investment adviser for MEMBERS Mutual Funds. MEMBERS Capital Advisors is the nation's leading manager of credit union and credit union member investments.

August 16, 2004