By Tim Amero

CFP

During the past three years investors have been bombarded with so much bad news that there is little wonder as to why many investors are experiencing much anxiety as is reflected by a lack of investor confidence that has led to the movement of trillions of dollars into CDS and Money Market Accounts.

It is not difficult to understand why current events have undermined investor confidence.

4 Unexpected attack on our homeland.

4 Rapid increase in debt both personal and governmental.

4 Bankruptcies and accounting scandals.

4 The war in Iraq.

So many negative events in recent years induced investors to flee from the market to fixed rate accounts causing a collective loss of about eight trillion dollars since March of 2000 when the NASDAQ peaked at 5,048. However, please note there may be reason to hope since the Nasdaq has risen from 1,114 on 10/9/2002 to 1,765 on 8/22/03, a 58% increase.

Market psychology

For an investor to cope with market anxiety, it is important to understand what it means for the market to return to normal. For the short term the market experiences bubbles, where investors bid stock prices up to ridiculously high levels. For example, in the five-year period from January 1995 to December 1999, investors realized an average annualized return of 24.6%. Although in the past 75 to 80 years, the average market return was only 8 to 10%, investors were caught up in a wave of increasing stock prices.

For example, prior to March 10, 2000, investors were pouring assets into the dot-coms in the belief that even though many of these companies were not posting any earnings that by buying low and selling high that they had the potential to realize high return on their investment. The result was that many of these stocks were bid up to ridiculously high prices. Many of the price to earnings ratios had reached 400 to 500 times projected earnings.

When investors began to realize stock prices, in the long run, are determined by fundamental strength of the company as measured by price to earning and price to book ratios and dividends paid to the owners of the stock, the sell off began and the bubble burst as the negative factors listed earlier in this article occurred.

Although the following is a bit simplistic, bubbles are created and destroyed because

4 Greed drives the market when prices of stock, following periods of prosperity and high returns, because people start pouring money from CDs, Money Market and other fixed rate accounts into the market in the hope of obtaining a higher return even after the market prices have already advanced to unreasonable levels. This movement of funds drives stock prices up to even higher levels creating a bubble in the price of the stock.

4 Fear drives the market
during periods of recession and low returns. Many people bail out of the market even after the market prices have corrected to reasonable levels. This movement of funds coupled with other negative factors bursts the bubble, inducing more investors to flee and thereby driving stock prices even lower.

In both cases, the investor is managing his or her portfolio by the emotion of the times rather than following a well-diversified investment plan based on objectivity and founded on the investment goals of the person.

Appropriate planning – The antidepressant for market anxiety

When investors allow themselves to be caught up by the emotion of the times, very often they act adverse to their own interest: Buying high when bubbles in the price of stocks are being created and selling low as factors arise causing the bubble to burst resulting in a loss.

Goal setting

The most basic and most important rule:

“Successful investors set specific goals and understand the relationship of risk to return on their investments.”

There is nothing magical about acquisition of assets and it does not require luck or skill. However, it does require planning and discipline. My advice is build your wealth slowly with goals based on:

4 Assessment of self.

4 Well-stated objectives.

4 A Plan tailored to your needs.

Time perspective

Each goal you set has a specific time when the funds you are saving are going to be needed to finance that goal. For example, if you are saving for retirement in 20 years this is a long-term goal and generally speaking an individual can invest more aggressively for long-term goals than for short-term goals.

Furthermore, goals in the distant future are much easier to achieve because of “The time value of money.” Money under management earns interest, and for long-term goals the interest often exceeds the savings. Avoid “get-rich-quick” schemes. It takes 12 years to double your money at a 6% return. So you must save first in order to double your money. The most basic rule of saving is “Pay yourself first and spend second.”

The enemies of investment return

When saving for long-term goals, your investment return is reduced by the affects of inflation and taxes on your earnings. To minimize these effects on your retirement savings plan, you should include in your plan methods of savings that are tax deferred and have the potential to earn more than the rate of inflation. For example, you should always participate in 401k if offered by your employer at least up to any company match that may be available. If you do not have a qualified plan at work, then you should consider making contributions to an IRA account. Variable annuities also grow tax deferred and have the potential to outpace inflation.

Periodically update your plan

With the passage of time your long-term goals become short-term goals and your investments should become more conservative as the time approaches to use your savings. Monitoring your investments does not mean fretting over the daily ups and downs. Performance must be assessed in terms of market performance of similar funds.

Concluding remarks

Success in money management is not a result of fate, luck or chance. Success is easier if you have a plan and follow that plan. People are living longer than ever before. It is much more important to make wise decisions when investing because money set aside for retirement must last for a longer period of time. “The national savings rate has declined from 9% in the 1970s to under 3% today.”

So please don’t procrastinate: Pay yourself first and spend second.


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