Market Volatility and Your Portfolio

October 16, 2008

A crisis in the financial industry is coming to a head at a time when most Americans are already plenty concerned about their financial futures—creating a "perfect storm" of financial worry in many American households. Home values have declined, costs for food and fuel have risen and confidence—both consumer and investor—has eroded. In this environment, it can be hard to keep your perspective. However, the financial markets have survived wars, recessions, corporate scandals and other catastrophes over its long history. Despite these setbacks, the long-term direction of the U.S. stock and bond markets has been up.

It has been a rough ride in 2008, but consider the following points before making investment decisions based on the ups and downs in the markets:

A decision to pull out of the stock market can result in a substantial long-term setback. A 2006 study by DALBAR¹, a mutual fund research firm, showed that investor returns from 1986 through 2005 were only a fraction of actual market returns. The reason? Investors tend to move in and out of shifting markets—and failed on both counts.
A decision to pull out of the stock market can result in missing significant market gains. According to a recent Standard & Poor's study, an investor who missed just 10 of the top-performing days in the stock market between December 31, 1996 and December 31, 2006 gave up nearly two-thirds of the market's gains over the same period.² It's nearly impossible to catch up when you miss out on opportunity that large.
A decision to pull out of the stock market can result in missing a potentially swift and sizeable rebound. According to a Standard and Poor's equity research finding, once a bottom in a bear market has been reached, the S&P 500 Index* experiences a fairly swift and sharp surge in prices. Typically, the S&P 500 Index has recovered 33% of the point decline experienced in the prior bear market in approximately 40 days following that bottom.³ If you're waiting for a sign that it's safe to get back in, chances are you've already missed a big portion of the rebound.

*Indexes are not available for investment and do not reflect fees, brokerage commissions or other expenses of investing.

The economic challenges we face today are indeed serious. To help put today's crisis in perspective, consider the following factors about the U.S. economy:

Economic slowdowns are a normal part of the business cycle. We believe growth has slowed and we are very likely entering a recession. Until all the information is available, it's hard to say exactly where we stand—or how long it will last. But recessions are a normal part of the business cycle; investors have endured them before and will do so again. Rather than reacting to the ups and downs in the economic cycle, investors should stay focused on their long term investment strategy.

Past performance is no guarantee of future results
Source: S&P returns from Standard and Poor's; GDP
growth figures from Bureau of Economic Analysis (BEA).
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U.S. unemployment has grown, but nowhere near Depression levels. As of September 2008, unemployment has risen to 6.1%, and could increase further if the economy continues to slow; however, the current rate is far below levels observed in the Great Depression where unemployment reached 25%. Regardless of the health of the job market, you should always maintain a savings cushion and avoid unnecessary spending whenever possible.

Inflation remains relatively low. Americans who lived through the 1970s remember double-digit inflation and, only a couple of months ago, oil and other commodity prices sparked concerns that inflation would, once again, spiral out of control. Inflation is still beyond most economists' comfort zone; however, slower growth has lead to less demand for industrial metals, oil and other inputs and created excess manufacturing capacity, easing inflationary pressures. Regardless of short term inflation trends, over the long term, inflation is a key factor when evaluating investments—especially bonds. If you are not sure how inflation will impact your investment returns, consult with someone specially trained to help people with their finances.

And one more thing:

We've been here before. Past performance is no guarantee of future results, but the global economy has overcome obstacles many times before. As difficult as it may be, don't let your emotions drive your investment decisions. Recent events highlight the need to have a financial plan that you are able to follow regardless of market swings.

Now is a good time to review your portfolio to make sure you are comfortable with the risk associated with your investments. If you have any questions about your funds, call a Financial Advisor at AARP Financial at 1-888-778-6187. Our advisors are non-commissioned professionals who will take time to help you make sense of what is going on in today's markets.

Sincerely,
Richard M. Hisey
President
AARP Financial

1 A $10k investment is made in a pattern identical to the "average investor" behavior for 20 years. Rates of return that are identical to the "average investor's" return are applied each month. This is compared with a $10k investment, evenly distributed across each month for the same 20 years and earning the rate of return of the S&P 500. The resulting dollar values of both scenarios are annualized and compared. The "average investor" refers to the universe of all mutual fund investors whose actions and financial results are restated to represent a single investor. A copy of this study is available upon request from AARP Financial Inc.

2 Source: Chart Source, Standard & Poor's Financial Communications. Stocks are represented by Standard & Poor's Composite Index of 500 Stocks, an unmanaged index that is generally considered representative of the U.S. stock market.

3 Stovall, Sam. Standard and Poor's Equity Research, September 28, 2008.

The Financial Advisors are investment adviser representatives of AARP Financial Inc., a registered investment adviser.

While AARP endorses the services provided by AARP Financial Inc., AARP does not offer financial products or services itself and cannot recommend that you or any specific individual should purchase any particular product or service. AARP Financial Inc. is a registered investment adviser and a subsidiary of AARP.