1st Quarter 2011
April 15. 2011

As we end the first quarter of 2011, the US economy continues to show signs of recovery. This is evident in GDP, earnings and the overall level of the equity markets compared to 2009 levels. If you look back at the stock market from the lows of March 2009 through March 2011, the S&P 500 and Dow Jones are up almost 100%. However, there are still areas that continue to cause concerns such as housing, employment, deficits and energy prices. Amidst all of good and bad data points, we are always brought back to one key aspect of investing that does not get enough attention: investor behavior.

The last two years have shown us yet another example of what investor behavior looks like during a market correction. Unfortunately, it is not a positive lesson but one we can learn from none the less. If you consider the old mantra of investing we all know the goal is to “buy low and sell high”. It is very easy to say but hard to do. In fact, looking back on October of 2008 investors pulled a record $72 billion from equity funds as the market went down. Remember, the market peaked a year earlier in October of 2007 when the Dow was over 14,000. Instead of selling high the average investor waited until the Dow was below 10,000 to sell low. The same thing happened in 2009 and 2010 but it was investors pouring money into bond funds ($350 billion – 2009, $222 billion – 2010) at a time when they should be buying into equities.

Perhaps another way to examine investor behavior is by considering the actual return an investor receives when buying a mutual fund. Author Nick Murray, a favorite of ours, recently wrote an article about the best performing equity mutual fund of the “lost decade” from 2000-2009. During that period of time, the overall markets ended up about where it started 10 years earlier. The best performing equity mutual fund of that period was up an average of 18.2% a year while the average investor enjoyed a minus 11% return. How did that happen? After returning 80% during 2007 the fund received an enormous amount of new money from investors chasing return at the peak of the market. When the fund dropped 48% in 2008, a majority of those new investors panicked and sold the fund at a 50% loss. Investor behavior or the lack of certain behaviors can prevent many of the common mistakes that are replayed over and over during market corrections.

We mention these examples because they are difficult to discuss during periods of panic. At the present people feel better because of the recovery of their portfolio values and the positive outlook ahead. We feel the conditions are in place for continued economic expansion in 2011 but we can never predict when the next correction will come. We always want to prepare ahead of time to be able to take advantage of corrections rather than be fearful of it. We continue to keep portfolios balanced between stocks and bonds to weather any situation but most importantly to protect against long term inflation. This is still the biggest risk to preserving and maintaining purchasing power in the future.

As always, we appreciate the trust and confidence you have placed in us.  The positive returns of 2010 are directly related to your patience during the last correction and we are grateful for it. We welcome any thoughts, comments or questions and look forward to seeing you at your next Review Meeting.

Daniel P. Michalk, CFP®, ChFC