What the past teaches us about investing

Since the daily volatility in the stock markets ratcheted up last October to levels rarely experienced before, I’ve received numerous calls from clients who needed to hear an alternative view to the media’s overwhelming 24/7 “end of the world as we know it” mantra. One especially agitated client blurted out as I picked up the phone, “I know what you’re going to tell me, but I just need to hear it.”

Have there been days in the last nine months when your investor temperament bordered on panic or on emotional distress? If so, you are truly not alone.

Clients expect their advisers to be unemotional about their money even while they can’t sleep at night or are afraid to open their monthly account statements. I suspect that the fruited plains are rife with similar investor behavior. As long as that behavior does not get irrational, then fine. If it does, then such investors may be prone to make the big mistake that can be summarized as the following: “Sell low, buy high.”

Remember market history

In a recent article, I wrote about “this is what it feels like to buy low” and about the headlines from 1990 which mimicked those of today’s market decline and recession (Cardiology Today, January 2009). Let me give you some more market history to think about.

Kenneth W. Rudzinski

Unemotional facts about similar times may help you cope with the extreme distress you might feel as you flip on your favorite cable show to see how much money you “made” or “lost” today. I’m not saying that a trip through the past will turn the markets around. Hardly. But what it can do is change your focus from the daily DJIA bouncing ball to a much broader perspective of the various equity markets as they have repeated themselves over the last 50 years or so.

Let’s talk about bank failures: 22 of them in 2008 through December 1 and more ongoing, with 57 through April 2009. Big news, every time another one goes down the tubes, right? Why? We’re told that only 22 banks failed from 2002 to 2007, and 22 in 2008 alone!

Previous bank failures

But lest we forget, during the five years from 1987 to1991, 1,901 U.S. banks and savings and loan institutions either failed or required financial assistance from the government — more than one per day (Source: FDIC). So, 1,901 vs. 22; broadening your perspective can produce an altogether different mindset.

Through Dec. 1, 2008, the S&P 500 Index was down 37.7% year to date (YTD total return). This decline, had it persisted through the end of the year, would have rivaled the previous worst annual decline of the S&P 500 Index when it fell 43.3% in 1931.

Let’s see, 1931 = Great Depression; therefore we must be heading toward the Great Depression of 2009, as the pundits tell us again and again.

But that’s only half the story. The other half is that in the five years following 1931 (1932 to 1936), the S&P 500 Index gained 176%, or better than an average annual gain of 22% (total return) (Source: BTN Research). Although that 176% was not a straight line up — market recoveries never are — it did represent a pretty good take-home gain, right?

Market reversal can happen

Do real, pertinent facts like these mean we are surely headed for a lasting bull market rally throughout 2009? No, not at all. But what they tell us is that the worst of times can in fact be followed by a significant market reversal and the good times that we hope for but fear may never return.

Remember this: There was no reason a person in 1931 might have had reason to be optimistic about the markets in years to follow, like now. But the sum of those next five years was significant!

On Nov. 20, 2008, the S&P 500 plunged to its lowest closing point of the year, down 51.9% from its peak on Oct. 9, 2007. By March 9, 2009, it had fallen further to 56.17% from its previous peak. The magnitude of both of these declines was the worst since 1942 (Source: BTN Research). No reason for optimism right now?

No reason for people in 1942 to be optimistic either as the United States prepared for war after a decade of the Great Depression (preceded by the stock market crash), a real estate crash, massive unemployment, credit contraction, plummeting agricultural commodity prices, the bombing of Pearl Harbor, etc.

Seemed then like the future was nothing but doom and gloom. Sorta like now, maybe?

When others are fearful

Ponder this for a moment: From April 1, 1942, an investment of $10,000 in the S&P Composite Index returned 54.27% 12 months later. Further, it gained 19.54%, 18.53% and 17.12% annually over the next five years, 10 years and 20 years, respectively, to $236,035 at the end of the 20 years (Source: Lord Abbett Distributor, LLC). From the worst of times to the best of times!

As Warren Buffet says, “…be greedy when others are fearful.”

The same market reversal occurred from the depths of the 1973 to 1974 recession. We had the OPEC oil embargo; high energy prices (remember the gas lines?); Watergate; a war in the Middle East in 1973; and high inflation, interest rates and unemployment. Then there was the Chrysler bailout in the mid-70s.

But if you had invested $10,000 in the S&P 500 Index (you couldn’t, but let’s pretend), you would have earned an annualized return of 38.13%, 16.86%, 15.63% and 15.11% over one year, five years, 10 years and 20 years, respectively, or $166,942 over the 20 years (Source: Lord Abbett Distributor, LLC).

But would you have had the courage to do that then? Do you now?

Will such investment histories repeat themselves? Maybe yes, maybe no, because past performance is no guarantee of future results. But the next time you are watching TV or reading the hometown newspaper and they are both dripping with pessimism and fear and doubt, remember that a crystal ball view of the future without a corresponding trip through the past may give you only a distorted and incomplete vision of the reality that the equity markets demand.

So, when clients call seeking peace from the storm, my tale to them of the future is a firm glimpse of the past.

If you send me an e-mail I will forward to you the complete Lord Abbett data referenced in this article.

Ken Rudzinski is a registered representative of Lincoln Financial Advisors Corp., a broker/dealer (Member SIPC) and registered investment adviser. Insurance offered through Lincoln affiliates and other fine companies. 2036 Foulk Rd. Suite 104, Wilmington, DE 19810; (302) 529-1320; kenneth.rudzinski@lfg.com. CRN 200905-2029682

Lincoln Financial Advisors Corp. or its representatives do not give tax or legal advice. The information in this article is from sources deemed reliable. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances. CRN 20012-2024060