It never hurts to play it safe
- Alan Lavine and Gail Liberman
The markets are extra volatile and unstable these days.
So it could pay to keep plenty of money in cash, high-quality bonds and government-guaranteed investments--particularly if you are retired or nearing retirement.
Stephen Leuthold, president of Leuthold Weeden Capital Management, Minneapolis, recommends keeping no more than half of your money in stocks. Leuthold is a highly regarded analyst and money manager. He believes that we haven't seen this kind of unstable international climate since the Cuban missile crisis.
Some pessimistic economists say that future terrorist attacks could hurt business productivity. Research by Alberto Abadie and Javier Gardeazabal, published last year by the National Bureau of Economic Research, Cambridge, liken possible effects of future terrorist attacks to the 1970 oil crisis.
In addition to political risks, other economists say the law of averages also is catching up with the stock market. Over more than 70 years, stocks have grown at an average of a little over 10 percent annually. That does not mean you earned 10 percent every year. It means that if you totaled up the amount that $1 grew to over 70 years, the average return was 10 percent. There were good years and bad years along the way.
Over the past 15 to 20 years, stocks have averaged way above 10 percent. In the 1990s, the S&P 500 grew at a 25 percent annual rate.
But stock market performance always moves back to its historical average. So brace yourselves.
Some economists, like William Sharpe, Stanford University, say that going forward, the stock market should average about 7.5 percent annually.
Roger Ibbotson, finance professor at Yale University, says stocks should average 9.37 percent over the next 20 years.
Meanwhile Eugene Fama, finance professor at the University of Chicago, says stocks should grow at annual rate of around 7.5 percent.
A forecast is a 50 percent-50 percent estimate of what you should earn. You could more or you could earn less. Historically, stocks have averaged exactly 10.7 percent annually since 1926. However two-thirds of the time in any given year they return between -11 percent and +32 percent.
With that much margin of error and lower forecasts of long-term stock returns, we could expect to lose more money in the stock market than we have in the past.
After all, if you hold stocks long term and average 7 percent or 8 percent rather than 10 percent, you can expect more losing years, years with bigger losses or years of lower gains.
Alan Lavine and Gail Liberman are husband and wife columnist and authors of The Complete Idiot's Guide To Making Money With Mutual Funds, (Alpha Books).
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