Smart401k Blog

Well, its finally here - a Bear Market.

As many of you know, two popular measures of U.S. stock market performance are the Dow Jones Industrial Average, and the NASDAQ Composite Index.  Wednesday, the Dow Jones Industrial Average closed at 11215.51, down 20.8% from its record close hit last October. A fall of 20% from the last market high is traditionally considered the definition of a Bear Market. The technology-focused Nasdaq Composite Index skidded 2.3% to end at 2251.46, also entering Bear territory.

From a historical perspective, no two Bear Markets have been alike.  But we can get some ideas of what to expect in the coming months by looking at the averages and extremes of market performance in the more recent Bear Markets.

First, a definition:  A Bear Market starts when stocks begin what turns out to be a 20% decline from its previous high point. It’s end is the bottom — seen only in retrospect after stocks have recovered by 20%.  So, the timer starts today, and we won’t know the end until we surpass the market highs hit last October. Now let’s look at some statistics for Bear Markets since 1960 (sources The Wall Street Journal/Ned Davis Research):

Number of Bear Markets since 1960:  9

Average length of time: 14 months

Shortest Bear Market Time Period: only a few months

Longest Bear Market Time Period:  A little more than 2 years

Average market decline: 31%

Smallest decline: 21% (remember it has to be at least 20%)

Largest decline: 45% (during the 1970s oil crisis)

With this wide variety of declines and timeframes, we want to point out three investing tips and reminders that our long-time readers have seen before:

1.  Don’t think about trying to time the market, or think you know when the market bottom will occur.  We don’t try to time the market and don’t know of anyone who consistently can.

And please don’t just move everything into money market funds because you are nervous about losing more.  Remember - what’s important is where your balance is when you are retired, not when you are building up your savings.   If the drops in your investments are causing you to lose sleep at night, consider changing the level of risk in your investments.  Smart401k clients can get recommendations for reduced risk portfolios by signing into their account and retaking the Risk Tolerance Questionnaire.

2.  Make sure you realign (rebalance) your investments to your target allocation percentages.  This is a very uneven market - growth funds are outperforming value funds, domestic funds have been outperforming international funds.  Emerging Markets funds have experienced wild swings (the average China stock is down 48% this year, while South American company stocks are up slightly).  Chances are some of your investments have moved up or down significantly more than others.  If you don’t rebalance to your target percentages, its likely that your overall investment risk has changed.

3.  Don’t stop putting money into your account.  Someone once said that stocks and mutual funds are the only things that people don’t like to buy “on-sale”.  If you have a reasonable time horizon, history shows that the markets and most likely your investments will rise over time (but, past performance is no guarantee of future results).

One way to look at the current situation:  the markets would decline by about 10% more to hit the average decline of a Bear Market.  If we assume that someday the markets will recover, as they always have in the past, the recovery will be at least 20% - actually 30% from the average market low.  By the averages, the upside is greater than the downside.  The always agonizing question is ‘when will all this occur?”  Based on history, the answer is, we won’t know until it’s already happened.

One last statistic:  Number of Bear Markets where a recovery never occurred:  zero.

Scott Revare

CEO, Smart401k

By now most people have received their stimulus checks.  Like many others, I felt it was my duty to spend the money as quickly as possible to help stimulate the economy.  After all, that was the Government’s intention when announcing the refund, right?  Well after dreaming of all the wonderful things I could use the money for, I started to realize there were better options than just spending it on material goods or a night out on the town.  More urgent day-to-day needs and my longer term retirement goals came to mind.

While I was thinking through my own financial situation, I realized that it might be useful to share how I prioritized potential uses for my stimulus check.  At the top of my list are the day-to-day expenses that we all have such as food and gas.  With gas prices reaching all time highs and about to pass $4.00 per gallon, people have to pay more and more each time they go to the pump.  My co-workers and friends are now paying anywhere from $45 to $100 to fill up their car or truck, and as a result have far less for things like going out to dinner. 

After accounting for day-to-day living expenses, I turned my attention to high interest credit card debt.  If you consider the average household credit card debt is roughly $3,000 with an APR around 19%, it makes sense to try to pay it off as soon as possible.  In fact, a survey by the Harris Poll revealed that 38% of respondents said they will use a lump of their rebate checks to help pay off credit cards.  With such high interest rates, especially those with APR’s above 15-16%, it only makes sense to use this money to pay off credit cards.

Next on my list would be adding to an emergency fund or possibly funding an investment account.  In the Harris Poll mentioned above, over 35% said their rebate checks were going straight into their savings account. I think this is a great idea for those that are building an emergency fund and suggest six months of living expenses as a goal. If you have your day-to-day expenses accounted for, don’t have high interest credit card debt and have an emergency fund built already, you might want to consider investing it.

By using the stimulus check for these expenses, you will free up some money from each paycheck.  I’d suggest investing this portion and increasing your contributions to your 401k.  Unfortunately, I have seen a recent trend where people are doing the opposite, and are actually reducing their 401k contributions.  This trend will have long lasting effects. You might not see it now or in a year, but 10, 15, or 20 years from now, you will see the dramatic effects.  (To see how a change as small as 1% could affect your retirement plan try the “What May My 401k Be Worth?” calculator on the Calculate Your Progress page.)

There are many different options for how to use your stimulus check.  Instead of feeling obligated to spend the money on electronics or entertainment as I first did, I simply ask that you take a look at all of your options and decide what is best for you and your family.

Jeff Studebaker, Investment Advisor

The sharp, quick drop in the market at the start of 2008 makes it easy to forget the slower, across the board market drop in the fourth quarter of 2007.

Here is how the year finished:

Data provided by Morningstar. 3 and 5 year returns are annualized.  Bold items are indexes for comparison purposes   The S&P 500 is often used to represent the performance of the overall US Market. The MSCI EAFE ND Index is used to approximate the performance of the overall foreign equity markets.  The Lehman Brothers Aggretage Bond Index is used to approximate the overall performance of US Bond markets.  The 3 month Treasury Bill performance approximates the overall performance of short term fixed income investments such as money market funds. Market Performance Commentary

• While every US based market asset class declined in this last quarter, value Oriented Funds had the biggest across the board decline. Large, Mid and Small company value oriented funds were all down at least 5% for the quarter. Growth oriented US funds all performed measurably better. From the perspective of all of 2007, here are the differences in returns between value and growth oriented performance, by category: (subtracting the 2007 growth return from the 2007 value return)
  • Large Companies: 11.93 %
  • Mid-sized: 14.26 %
  • Small: 13.67
• When looking at these same spreads over a 5 year annualized timeframe, we get these differences
  • Large Companies: -0.41 %
  • Mid-sized: 0.78 %
  • Small: 1.05 %

This large 2007 spread is remarkably similar by asset class, and once again shows the importance of diversifying across asset classes and in mutual funds that invest in the different sized companies. The smaller spread over a 5 year timeframe illustrates the historical evening-out trend of returns over longer time period. Recall that in 2005 and 2006, value funds outperformed growth funds and mid and small company focused funds outperformed large company focused funds.  Now the tables have turned.  While our Smart401k allocations have been overweighting growth funds for the past year and a half, we are returning to a more even balance between the two, in anticipation of value oriented funds doing relatively well over the intermediate-term.  Over the past year or so, we’ve also overweighted large company funds, and continue to do so.

• International stock performance has continued to outperform US Equities. As can be seen in the performance chart, international funds, and especially emerging market funds, continue to outperform the US markets, although this past quarter, they also experienced reduced gains. Our recommended allocations now have international funds at close to “normal” levels.  While we continue to believe that emerging markets have a much higher than normal chance of returning to earth in the coming 6-12 months, we also believe that diversification across both US and international funds is important to our clients in the face of the high volatility in the US markets.

• Taking a longer-term perspective on market performance, the overall markets as measured by the S&P 500 are up an average 8.62% per year over the past 3 years, and 12.63% per year over the past 5 years. It’s interesting to note that with the exception of large company growth funds which trail by a small amount, every US Equity category listed above exceeds the S&P 500 for the 5 year annualized time period.

In comparing the 5 year performance of the Lehman brothers Aggregate bond index (a measure of the overall bond market) to the S&P 500, we see that the 5 year average performance advantage of US equities over bonds is over 8% - a healthy difference.

• One market characteristic that isn’t factored into the market performance averages shown in this table is market volatility.  As we’ve previously noted, after a period of relative calm, volatility (sharp short-term market increases and declines) has returned to our markets with a vengeance.  As of January 14^th, the S&P 500 is down more than 11% from highs reached in early October, putting us once again in correction territory.  Thus far in 2008, we’ve seen a negative swing of -4.5% in the S&P 500 through January 11^th. We expect continued market volatility in the near future.

Yesterday, both of traditional measures of the overall US Markets dropped to levels that fit the textbook definition of a correction.  The benchmark S&P 500 dropped 2.3% Monday, erasing its 2007 gains and leaving it 10.1% below its October 9th high (down .8% for the year).  The other key benchmark, the Dow Jones Industrial Average fell 237.44 points to show a 10% decline since its October 9th high. The Dow still shows a gain of 2.2% for the year.  The S&P 500 has been hit a little harder than the Dow primarily because it is more heavily weighted with financial stocks, which have declined more than the rest of the market.

Here are a few statistics and comments to put things into perspective (please refer to our prior blog on Corrections and Bear Markets):

• Historically, corrections are fairly common occurances -there have been 43 corrections since World War II.  Corrections have occured less frequently since the 1990’s. The last correction we had was in 2003.
• The average correction is a decline of 15% off of a market high.
• One in four corrections turn into Bear Markets (market declines of 20% or more) according to Ned Davis Research in Vinice, Florida.
• The length of time from the market high on October 9th to yesterday was less than 50 days. The last 16 corrections have averaged 148 days to the low point, and 111 days to recover back to the original high point in the market.

A final note: the label market correction is important to near term market performance because it is indicative of a broad drop in the market and it has a near-term impact on investor behavior.

By Scott Revare CEO, Smart401k.com

 What a ride we had this past quarter. Here are a few notable highlights:

• The US Stock Market (as measured by the S&P 500) hit a record historic high on July 19^th.
• From July 19^th to August 15^th 19 market days - the market dropped 9.4% - almost an official market correction.
• 36 market days later, on October 5^th the market recovers the 9.4% drop and hits a new historic high.
• USA Today noted that since 1950, the Standard & Poor’s 500-stock index has posted a daily loss of more than 2% on an average of four days a year. Yet in just the past nine months, the S&P 500 has posted daily losses of more than 2% six times.
• USA Today also noted that the Dow Jones industrial average gained or lost more than 1% on 24 days in the third quarter the same number of times it did for all of 2006.

In a few short weeks the market showed us both its resilience and its newfound increased volatility. So as retirement plan investors with a long-term viewpoint - what lessons can we learn from this wild ride of a third quarter?

1. Hanging on for the ride can pay off.

It really came back, didn’t it? It seems like human nature leads us to want to do something to defend ourselves when confronted with bad events. We also seem to think that when the market drops, it will just keep going down. Whenever the markets drop significantly in one day, or over a few days, our customer call and email volume increases over 30% at Smart401k. People inevitably ask our advisors what they should do they seem to expect us to tell them to quickly sell - bail out before it’s too late! But the best prescription for long term investors is to do nothing - just hang on for the ride. Historically, the markets have always gone up over time. As long as you are properly invested (i.e. diversified) and have the luxury of 5 or more years to wait, history says time is on your side.

2. Prepare yourself for market volatility.

There are two important things to keep in mind during times of market volatility.  First, be mentally prepared. The worst thing you can do is let emotions take over and start making decisions that are not consistent with your long term investment approach. Take a deep breath and make sure you are approaching any investing decisions with a long-term perspective. Second, if market volatility keeps you from sleeping at night, consider changing your long-term investing strategy. By increasing your fixed income (e.g. bond) holdings, and decreasing your equity holdings (stock mutual funds), your overall investments will experience less ups and downs. This most likely means your investment returns will be less over time, but your health and well being is more important.

3. Keep investing.

The funny thing about market drops is that they usually are accompanied by large-scale pullbacks from investors. Many investors sell what they have, and even more stop their contributions to their retirement accounts. Investors withdrew $12.3 Billion dollars from stock funds in August. Yes, that’s the month that the S&P hit its quarterly low. In the months since, the market hit a new high. When you know you are going to be investing in the market over many years, isn’t it better to be investing when the market is lower?

4. Stay properly diversified.

It’s easy for market movements to put your investment allocations out of whack. Different types of investments grow at different rates over time. For example, international funds have grown faster than most US based funds this year. By getting your investments back to your target allocation percentages, you are in effect selling investments that are relatively higher priced, and putting your money in investments that are relatively lower priced, since they haven’t grown as fast. This seems counter-intuitive, as you would naturally think you should keep investing in something that has been going up. But this approach ensures that you are moving money out of investments that have already experienced higher than market-average growth before those investments inevitably experience a drop back to market averages. You are in effect œselling high and buying low.

If you stick to your long-term investing strategy and ride out any market gyrations, you put time on your side working to your advantage. Historically speaking, that’s a good thing.