I recently spoke to a group of investors regarding long-term stock market trends. I told them that my belief was that we are in the middle to late stages of a secular (long-term) bear market that began back in 2000. Since that time, the S&P 500 Index has had two significant declines. The first was a drop of 49 percent, from March of 2000 to October of 2002, and the second for a drop of 57 percent (October of 2007 to March of 2009). These declines were then each succeeded with stock market gains in excess of 100 percent.
With money markets paying zero interest, and the current 10 year Treasury bond yielding less than 1.7 percent, how are investors to proceed in this New Year? That is the question many were asking. I told them the answer depends on with whether or not they believed stocks are still in a secular bear market. If so, they would want to take a more defensive approach. If not, they would likely want to take an offensive strategy, owning more stocks in their portfolio.
I will tell you one thing for sure. If you have not reviewed your investment strategy over the past few years, it is long overdue. Forget about gains and losses of the past, and focus on the investment strategy you are most comfortable with.
Lets take a look at three investment strategies and understand how they apply to different market cycles. They are: passive, tactical, and absolute return.
Here is a brief description of each.
* The Passive Strategy is how many people have invested for years. It is also known as the "buy and hold" approach. This strategy typically invests in asset classes such as stocks, bonds, and money markets. This strategy is for those with longer time horizons and who have less concern for market fluctuations. Asset class allocations are periodically rebalanced back to the original portfolio allocation to stay consistent with ones risk tolerance.
Passive investing works best in a bull market since other than rebalancing, one stays invested and rarely makes changes. This is more of an offensive approach since markets move higher during bull markets. If the market should drop significantly, long-term thinking and patience is often required to wait it out for a rebound in the market.
* The Tactical Strategy sets up an allocation using similar asset classes used in the passive strategy, but actively manages changes in the allocation based on market conditions. This strategy often utilizes additional defensive or opportunistic investments to manage risk or take advantage of opportunities. It is best used in sideways markets.
Although this strategy is not immune to market declines, it should provide more downside protection when compared to the typical "buy and hold" strategy. Conversely, in a rising market, it may lag in terms of performance.
* The Absolute Return Strategy is an approach that attempts to minimize and manage downside risk. This approach often uses several hedging techniques, and can work well not only in sideways markets, but in down markets as well. It is appropriate for someone who seeks preservation of principal as a priority, but wants to keep pace, or hopefully exceed, the rate of inflation.
Principally, this strategy considers risk in terms of losing actual money rather than underperforming a particular benchmark such as the S&P 500 Index. Securities that are selected for this strategy typically only make sense if they are offering a good expected return relative to their risk of loss.
No investment strategy can eliminate the risk of fluctuating prices and uncertain returns. However, be comfortable with your strategy as you need to sleep at night and worry less about your investments.
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