The first quarter of 2012 has just ended. You probably noticed gains in your equity based investments. You also probably noticed one of the many headlines trumpeting that the Standard & Poor’s 500 (S&P 500) Index for the now-concluded first quarter of 2012 had a 12.00% gain; the biggest first-quarter gain since 1998.
Lets add some perspective to this very welcome and exciting development starting with a brief description and discussion about the S&P 500 Index – a weighted index of 500 large US corporation stocks. Indexes such as this are benchmarks for market performance, specifically they are an indicator of whether the market is rising or declining, and by how much. There are several major indexes that serve as bellweathers for US equities markets that include: the Dow Jones Industrial Average, the NASDAQ, the Wilshire 5000, and the Russell 2000. When you look at financial information in magazines, newspapers, financial papers, and on many web sites, you usually see some or all of these indexes quoted and charted. You will also see other sector-specific and glogal indexes intended to represent market activity. Generally speaking these indexes are averages of specific equities, so the law of averages applies. That is – if all or most major equity indexes have increased over a period then the sentiment of the stock market for that period is positive and, on average, equity values have increased. Specific equities including those within mutual funds and ETFs may not track market index movements, so it cannot be said that all investments increased in value. However what can be said is that investment portfolios that are properly balanced and include index-based instruments are likely to track the sentiment and gains represented by commonly used market indexes. Passive management of index-based funds generally keeps costs low, thereby amplifying growth by compounding. At Union Financial Partners we preach and practice creating diversified investment portfolios that include index-based passively managed funds.
When 2012 started could you have known that market returns for the first quarter would rise? Could you have known that the increase would be the best since 1998 (as measured by the S&P 500 Index)? Were you invested in the market to take advantage of these gains?
Our point in raising these questions is that you cannot know when the best day, week, quarter, or year will occur. If you were invested with a diversified investment portfolio throughout the entire quarter, then the value of your portfolio most likely rose. Capturing salient gains when they occur is critically important to the growth of an investment portfolio. This should not be misconstrued with jumping into the market after major gains occurred! Periods of substantial gains, often single days, occur very quickly and at random and cannot be predicted, which is why we stress disciplined investment management and remaining invested through market declines.
Several analyses reveal that missing “best days” in the market (days with the highest relative gains) has a very significant impact to the growth of a portfolio and a person’s wealth. The “Tips For Coping With Market Volatility” provided on our web site show that missing the best day of market gains resulted in ten percent (-10%) less realized returns over a 10-year investment period. This is worth repeating – if the best day was missed, then the portfolio’s growth is reduced in absolute dollar value by 10%. If the 5 best days were missed is even more significant; returns in that example were reduced by thirty five percent (-35%)! The 2012 Andex® Chart compiled and provided by Morningstar® includes a section on the “Cost of Market Timing” that reveals that missing the ten best days in the market between 1992 and 2011 reduced the annualized return rate of large-cap US stocks by almost half; from 7.8% to 4.1%. Even more striking is that the difference between the maximum returns and negative returns during that period are the 30 best days. Why would any of the best days be missed? The common reason is an investor becomes overly anxious and tries to minimize further perceived losses by selling their equities for cash and waiting for a better time to reinvest. In other words, the investor is attempting to “time the market”. Usually such an investor monitors the market and returns into the market after seeing a large increase, but of course this same investor misses and does not capitalize on that very important increase. In addition to missing large and salient increases, the transaction costs of jumping in and out of the market further depress the overall gains of a portfolio.
Against a backdrop of economic uncertainty, including the financial debt crisis in Greece, markets posted exceptional gains for the most recently ended calendar quarter. With or without the aid of a professional investment advisor, if you exercised discipline and were invested throughout the first quarter of 2012, and if an appropriate percentage of your holdings (the “growth component” of your portfolio) were diversified and included equities in US companies and/or mutual funds that track major US equity indexes, then you captured important gains that will positively impact the future growth of your investment portfolio and the growth of your wealth. As is stated in the Investment Management section of our web site: “Time in the market is critical to maximizing the growth of your wealth. Timing the market (or attempting to time the market) is more likely to restrict the growth of your wealth or result in actual losses”. We hope that the current bullish quarter helps you to appreciate and benefit from the wisdom of “time in the market”.