Embracing volatility with investing.
January 9th passed quietly, as the third anniversary of the article “Spooked by Stocks”, which was printed in the January 9, 2010 issue of the Lancaster Intelligencer Journal. The article bemoans the experience of a 65-year old roofing contractor who sold all of his stock positions. He left the stock market because he was sick of the volatility and the crooks on Wall Street. The investor said he moved all of his money into bonds.
This investor succeeded in avoiding some nasty volatility over the past three years, but at what cost? The S&P 500 index is up 36% since the end of 2009, which works out to an average of 10% per year, while the 10-year Treasury note has barely kept pace with inflation. The investor may not have seen his portfolio decline in dollars terms. However, if the retired contractor has been spending the bond interest to live on, his purchasing power has been declining each year. He has traded volatility for a deteriorating standard of living.
No one likes to see their portfolio decline like we did in the great panic of 2008. Rather than fear volatility, investors should learn to embrace it as a natural part of investing. Part of the portfolio should be allocated to stocks, to provide the growth needed to fight inflation. Another portion is allocated to bonds, to reduce volatility. Finding the right balance and sticking with it through the market ups and downs is a path to successful investing and maintaining your standard of living throughout retirement. The balanced composite index* had a 9.4% annual return over the past 3 years which would have supported a 4% prudent withdrawal rate, while allowing the principal to keep pace with inflation.
*Made up of two unmanaged benchmarks, weighted 60% Dow Jones Wilshire 5000 Index and 40% Lehman Brothers U.S. Aggregate Bond Index through May 31, 2005; and 60% MSCI US Broad Market Index and 40% Barclays U.S. Aggregate Bond Index through December 31, 2009, after which the Barclays index was replaced by the Barclays U.S. Aggregate Float Adjusted Index.