During periods of distress in the capital markets we often hear from investors who, rather than hold a portion of their portfolios in common stocks, tell us they plan to hold cash, in order to “wait to see what will happen” and later “get back in when things are more certain.” We understand their apprehension in light of world news, but the fact is such a day will never arrive. We hasten to add that uncertainty is hardly a bad thing; without it, after all, we would expect no additional return.

It is our job to address these arguments head on. The fact is, despite media hype, not all investors are panicked and markets are continuing to function by pricing securities according to their perceived risk. For every pessimistic seller there is an optimistic buyer, and market prices simply reflect a consensus opinion regarding future earnings and prosperity. But that consensus changes quickly and dramatically, and this tendency exacts a steep price
from those who hope to prosper by sitting on the sidelines waiting for a better day.

Consider the early 1970s. Then, as now, the news was bleak: oil prices had quadrupled, price controls were imposed on food, 46 percent of adults feared a Great Depression akin to that of the 1930s and the Watergate scandal had forced a presidential resignation. A hypothetical all-global equity portfolio1 would have fallen 18.0 percent in 1973 and another 24.1 percent in 1974. But an investor who at that point abandoned the fully invested strategy by fleeing to the safety of cash would have missed out on a 48.3 percent return during 1975. More accurately, had he invested in Treasury bills in 1975 but then gone back into the all-equity strategy beginning in 1976, “after things had settled down”, his ending portfolio value five years later (through 1979) would have been 40.2 percent lower than it would have been had he simply maintained the fully invested strategy.

A similar story plays out in more recent bear markets. During 1990 the all-equity portfolio would have lost 16.2 percent, but would have rebounded 30.1 percent in 1991. During the infamous three-year “tech-stock meltdown” between 2000 and 2002, the portfolio would have lost 6.2 percent per year, but would have rebounded by 50.1 percent in 2003.

This is not to say that a very bad year, or years, will necessarily be followed by periods of extraordinary gains. Indeed it may take several years before the S&P 500 returns to its previous peak. The point is, no one knows how long it will take. That will be determined by events yet to unfold. We are confident, however, that investors who continually alter their portfolio based on current developments are playing with fire; it is an arbitrary approach that needlessly risks enormous opportunity costs. Fear is infectious in hard times, but the antidote is to maintain a balanced portfolio of stocks, bonds, cash and gold that methodically and deliberately pursues the risks and potential rewards that are inherent, but quantifiable, among these asset classes.

Also In This Issue

Modern Media Hyperbole Versus Social Science
Are You Ready To Retire?
The Ins And Outs Of College Financial Aid
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles