Thursday, November 27, 2008

Does "Buy and Hold" Work When the Market Goes Up and Down like a Yo-Yo?

This came in my inbox and was too interesting of an article to read.
We may benefit by following this advice!
Enjoy,
Mark

Does “Buy and Hold” Work When the

Market Goes Up and Down like a Yo-Yo?

I don’t know about you, but I’m a bit freaked out about the stock market. I know I’m relatively young, have a lot of time to recover, and that I don’t have a million dollars the market, but it’s very uneasy to think about the security of my invested assets in such a volatile market.

The day that I wrote this the S&P 500 index went up and down nearly 10%. To say that is volatile is an understatement.

You know what everyone says: If you are in the market for the “long-term” you don’t have to worry about the short-term volatility or losses.

I guess that sort of makes sense doesn’t it? Or does it?

This is a new very volatile world and I wrote this newsletter to give you something to think about and determine if buying and holding stocks right now is a good idea even when looking at the long term?

Ask yourself this question: If the stock market goes up and down and up and down over a ten year period with the average rate of return equalling ZERO, will the account balance be the same at the end of the ten-year period?


Put another way, if you invested $100,000 in the S&P 500 index where the index went up 10% the first year, then down 10%, then up 10%, then down 10%, and if this cycle continued for 10 years with the average rate of return equalling ZERO, would your initial investment still be $100,000?

The answer is NO!

Look at the following chart where I assumed a very volatile market that goes up and down 10% every other year and after ten-years the average return is ZERO. You’ll notice that the account value is $95,438.

Never go backwards and lock in gains

Most of you know that I’m a big fan of Fixed Indexed Annuities (FIAs) to hedge a client’s risk in the market and to earn decent returns when the stock market does well. FIAs are not a cure all. Not every penny of someone’s money should be in them, but as an asset allocation model, the older you get the more money you should have in a wealth building tool that will not go backwards.

What if the $100,000 invested in the above example instead went into FIAs? If I make a very conservative assumption that over time the cap on returns will be 8% annually, look at the results.

Initial Annual Return Acct. Initial Annual Return Acct. S&P 500 Investment Value Investment Balance Index FIA End Year 1 $100,000 10% $10,000 $110,000 $100,000 8.00% $8,000 $108,000 End Year 2 $110,000 -10% ($11,000) $99,000 $108,000 0.00% $0 $108,000 End Year 3 $99,000 10% $9,900 $108,900 $108,000 8.00% $8,640 $116,640 End Year 4 $108,900 -10% ($10,890) $98,010 $116,640 0.00% $0 $116,640 End Year 5 $98,010 10% $9,801 $107,811 $116,640 8.00% $9,331 $125,971 End Year 6 $107,811 -10% ($10,781) $97,030 $125,971 0.00% $0 $125,971 End Year 7 $97,030 10% $9,703 $106,733 $125,971 8.00% $10,078 $136,049 End Year 8 $106,733 -10% ($10,673) $96,060 $136,049 0.00% $0 $136,049 End Year 9 $96,060 10% $9,606 $105,666 $136,049 8.00% $10,884 $146,933 End Year 10 $105,666 -10% ($10,567) $95,099 $146,933 0.00% $0 $146,933 Ave.Return 0.00% 4.00%

Why did the FIA end up with an account balance of $146,933 instead of $95,099? Simple, in down years the FIA returned ZERO instead of -10% and in up years it returned 8%.


Are these examples real world? Prior to 1998 you would have said no way? Are these examples real world? Who knows, they could be. The question of the day is: are you doing everything you can to help educate and protect your client’s money in this uncertain world.


It’s one thing to have a conversation with your client where they are upset they only earned 8% when the market was
up 10%+, it’s another to have one with them when their money earned ZERO when the market was down 10%. The first one I don’t mind having, the second one is really painful (especially if your client is over the age of 60-65and close to or in retirement).


-20%

Just in case you are curious, if the market has wild swing of 20% every other year (up and down), the account balance at the end of 10-years would be $81,537 and the FIA account balance would remain at $146,933.


Conclusion

I’m not sure if the days of “buy and hold” have come and gone as a tried and true way of growing your wealth. That may or may not be the case. What I know is that it’s time to have a discussion with your clients to help them understand ALL the various options to grow and protect their wealth and I think that conversation should include the information discussed in this newsletter.

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