Monday, September 14, 2009

The Year That Was

You are all probably aware that the "financial crisis" has hit its one year anniversary. Believe it or not, it was a year ago when we woke up to the news that Lehman Brothers was going bankrupt, AIG was in BIG trouble, etc.. As we know, this catalyst evoked the global credit markets freeze and subsequent two month stock market plunge. On the morning of September 15th, I sent an e-mail to all of our clients, since we knew that the Lehman bankruptcy represented more than just a little bad news for investors. Here is a bit of what I wrote:

"...I have always said "don't panic, remain patient, and focus on the long- term". I am not changing my advice, and I still believe that we will benefit down the road by sticking with our long-term plans....Unfortunately, I don’t know exactly how bad markets will get or when they will turn around, but I truly believe the rebound will happen."

The table below shows what has happened in the global stock markets over the past year. Remarkably, the average of the asset classes that we follow is down only 7%, with international equities holding up much better than their domestic counterparts.

The table also shows annualized returns for the past 6 years. I chose 6 years, because we always recommend allocating client portfolios so that at least 6 years worth of living expenses are kept out of equity markets and kept in cash and bonds. That way there is no need to pull money out of stocks when they are tumbling like they did last fall. You can see that the average equity asset class return over the past 6 years has been 8.1% per year. Not bad when we consider that there were some who were predicting the end of capitalism not that long ago. 8.1% IRR is below the long-term average, but with inflation at around 3% over the past 6 years, that is still about 5% over inflation. This 5% also happens to be the assumed rate of return we use in many financial plans.

It is interesting to note how much better equity returns have been in the international markets. I remember back in the late 1990's when many respected investment "gurus" said that diversifying our portfolios into international stocks was unnecessary. Well, that certainly has not been the case. This is further evidence that listening to gurus is not a good way to construct an investment portfolio. We prefer to stick to the principals of asset allocation, global diversification and low costs as a way to capture the long-term potential of owning stocks.