Aug. 24 Memo to Clients re: Investing Pitfalls amid Market Volatility

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Given the continued sharp stock price declines on Friday, August 21st, and thus far on Monday, August 24th, we’re sending this follow-up memo to discuss the pitfalls of alternatives to our customary advice of maintaining your current stock allocation. Our advice presumes that stocks are a necessary part of your investment portfolio to meet your long-term financial goals. The following is a list of the main alternatives, and the key issues associated with each:

1) Sell stocks and buy back at lower prices. This is referred to as “market timing”, and is very hard to implement successfully. In addition to deciding the right time to sell, you also need to make the right decision about buying back into the stock market. If you wait too long, you miss the upside that has historically come from the stock portion of your portfolio.

2) Sell stocks and hold as cash. Short-term cash/money markets pay virtually no interest in the current low interest rate environment, and are guaranteed to lose purchasing power to inflation.

3) Sell stocks and buy high credit bonds. Since interest rates are very low (with the 10-year US Treasury benchmark rate close to 2%), these bond prices are very high, and remain vulnerable to the anticipated rise in US interest rates (although issues in the world economy may delay the Fed’s raising rates).

4) Sell stocks and buy high yield income investments, from US and international issuers. When stock prices are declining because of fears of worldwide economic slowdown, these investments also tend to decline as credit risks increase.

5) Sell stocks and buy alternative investments that provide hedging opportunities. This is another form of market timing, because while hedges may help during stock price declines, they will also hold back the extent of the gains during stock price recoveries. Issues of timing include when to buy these hedges and when to sell them; if held for the long term, the hedging costs might result in a lower return than simply maintaining the initial allocation without the hedges.

6) Sell stocks and buy commodity investments like gold, oil, and industrial metals. Commodity prices have been declining in recent years, and continue to be adversely affected by the same economic slowdown that the world’s stock markets appear to be reacting to.

It’s no secret that both the Wall Street investment community and the media have an interest in convincing investors to increase their activity and market participation when prices turn down. At Park Piedmont, we’ve evaluated these various alternative strategies and concluded that your long-term financial well-being is better served by maintaining the allocations to the various markets that we developed with you in calmer times.  We’re available to discuss any of these topics in more detail at your convenience.