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Our Philosophy |
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Our Team |
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What Sets Us Apart |
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Surviving Bear Markets
Risk,
Discipline, And Opportunity
When the market goes down, it usually takes investor confidence with
it. It is crucial for our clients to understand the nature of bear
markets and The Monitor Group’s strategy to overcome them.
Risk
Risk management is the most important
element of the investment process. As many investors learned during the
recent bear market, ignoring risk and focusing solely on potential
returns can be disastrous. The two primary sources of risk within
investment portfolios are business risk and market risk.
Business risk
is company specific and represents the danger of permanently losing your
entire investment in the stock of an individual firm. Business risk is
also known as diversifiable risk
because it can be practically eliminated through diversification. There
is no justifiable reason to subject a portfolio to business risk. With
diversification across more than 8,000 stocks in the equity portion of
The Monitor Group portfolio, business risk is virtually nonexistent.
The second type of portfolio risk is
market risk,
which refers to the up and down cycles of the overall market. With
business risk virtually eliminated through diversification, the primary
source of portfolio volatility is market risk. It is also referred to
as non-diversifiable risk
because it cannot be diversified away and is present in all equity
portfolios. The unpredictable nature of stock market cycles and
economic events will never go away. Therefore, it is important for
clients to expect these unavoidable cycles and more importantly to avoid
emotional reactions by staying focused on long-term objectives and
avoiding the urge to “bail out” during the inevitable downturns.
Discipline
Sticking to a carefully designed long-term plan and remaining fully
invested throughout these market cycles allows the investor to avoid the
pitfalls of panic selling and market timing. Panic selling results in
selling low while the markets are down and locking in losses.
Attempting to time the market and “get back in at the right time”
usually results in buying high after missing a significant portion of a
market recovery.
Markets usually
turn around quickly. Frequently, the majority of gains for any given
year are earned during one brief “spurt” over a period sometimes as
short as one month. Two good examples were the bear markets of the
early 1970s and the most recent downturn of 2000-2002. The S&P 500 was
down 14.67% in 1973 and 26.46% in 1974, only to come roaring back in
1975 and 1976 with annual returns of +37.21% and +23.85% respectively.
The S&P 500 generated a total return of 41.84% during the first six
months of 1975, and a total return of 14.97% during the first three
months of 1976. Following the most recent bear market of 2000-2002, the
S&P 500 returned 28.69% in 2003. The majority of the S&P 500 returns in
2003 were achieved over the two-month period of April and May during
which the total return was 14%. Discipline pays dividends!
Opportunity
Despite the unpleasantness of bear
markets, there are two valuable opportunities during these unavoidable
down cycles – Rebalancing and Tax Loss Sales.
Rebalancing serves
a crucial role in risk reduction. Rebalancing involves selling from
asset classes that have out-performed and buying into asset classes that
have under-performed. This allows us to maintain your target weights
for each asset class within the portfolio, which is essential to
preserving the low risk characteristics of your portfolio design.
Rebalancing also has a very positive effect from a performance
standpoint by systematically “selling high” and “buying low,” the direct
opposite of the market timing pitfalls mentioned above.
In
non-qualified (taxable) accounts, opportunities for tax loss sales often
arise during a downturn. Tax loss sales allow you to realize tax losses
that can be used to offset or “cancel out” taxable gains. If there are
more losses than gains in a given year, current tax law allows you to
take up to a $3,000 deduction against ordinary income and then carry
forward the remaining losses indefinitely. The key to tax loss sales is
to find a suitable alternative investment in the same asset class to
hold as a replacement for the one being sold. This allows you to remain
fully invested while simultaneously generating tax savings.
*****
Ken Robinson is a Senior Planner of The Monitor Group, Inc., a fee-only financial planning firm located in the Tyson's Corner area of McLean, Virginia. As a nationally recognized wealth management firm, The Monitor Group provides investment and financial planning services to more than 190 high net worth client families in Northern Virginia, Maryland, Washington, DC and across the country. Click
here for more information about Ken and The Monitor Group, Inc.
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