(Article from the San Antonio Business Journal by Mike McClain,
Jefferson Bank's Private Asset Management Group, 22 August 2008)

"On Wall Street, the most unnerving stock market reports since the Depression 1930s became daily more dismal.” — Time Magazine

“Investors have been frightened of an economy that seems out of control …The stock market has scarcely been so shaky since 1929… A Gallup poll published last month found that 46 percent of adults feared a depression similar to the classic one of the 1930s.” — Time Magazine

With stock prices slumping around the globe, and a barrage of grim news — falling home prices, rising costs for fuel and food, and the fragile health of the credit markets — these quotes could easily have been ripped out of a recent issue recounting the latest financial calamity.

However, the first was written in June 1970 and the later in September 1973. The country, our economy and capitalism righted itself, survived, and eventually thrived during each of these periods.

There is a natural human tendency to believe the challenges faced currently are somehow unique and more ominous than those faced previously. The cry of “this is the big one” has been heard many times before and failed to materialize.

History has shown it is unlikely any financial crisis or instability can ultimately defeat the financial system or cause lasting negative effects to a well-diversified portfolio.

While not always easy, remaining calm, focusing on the long-term and not letting emotion impact decision making are all important to successful investing.

Capitalism will continue to thrive here as it does in most developed and emerging nations. We will, as we have in the past, overcome the challenges we face whether it is the price of oil, jittery credit markets or the threat of recession.

History

Speaking of recessions, the U.S. economy has experienced 11 recessions since World War II. From the first day through the last day of those contractions, stocks delivered 7.1 percent vs. 5.1 percent for cash. So, according to Larry Swedroe with Buckingham Asset Management, even if you could have predicted the timing of every recession, you would have underperformed the market by moving into cash.

Believe it or not, contrary to popular opinion, our economy and the markets are likely to rebound even if our favored presidential candidate is not elected and the other one wins (whoever that might be — you fill in the blanks).

The antidote is a well-structured plan and time.

A well-structured plan is grounded on asset allocation and broad diversification.

Consider a portfolio composed of 30 percent U.S. large cap, 30 percent U.S. large value, 20 percent U.S. small cap and 20 percent U.S. small value stocks. The chart (see below) shows all years since World War II that ended with a negative return. As you can see, all years produced a good to exceptional return for the next five years, 10 years, and for the total 11-year period.

No doubt during a number of these years the pundits and financial writers were wringing their hands just like we know they did in 1970 and 1974 from the quotes referenced earlier.

We do not know, of course, whether the returns for the periods following 2002 and the current 2008 will look like most of history and reward long-term investors.

International and emerging markets were not included in this simulated portfolio due to their relatively short return history. In a real portfolio, however, we would certainly want to include these asset classes as they provide further diversification that minimizes volatility and increase long-term returns.

Time makes a difference and rewards the long-term investor.

Look at the numbers. From 1980 through 2006, an investor who missed out on the five best-performing days in the S&P 500 Index wound up with 26 percent less than someone fully invested during this period. If the same investor missed the 30 best days their return was reduced by 73 percent. Five of those years are on our chart.

Near term

What will the rest of the year have in store for the markets and when will they calm down? Despite what the pundits and Wall Street would have you believe, no one can accurately call markets or guess the direction of stocks. They might for a short while (call it luck), but there is no evidence that anyone can do it with any level of consistency.

So, instead of spending time watching 24-hour financial news, streams of financial forecast and the railings of Jim Cramer, ensure that your portfolio is properly allocated across asset classes and know that time favors the long-term investor and capitalism is a powerful force that creates value.

In case you were wondering about how the market did after those dire and gloomy quotes were published in Time, the S&P 500 was up 41.87 percent and 38.13 percent respectively in the following 12 calendar months.

Source: Dimensional Fund Advisors