November 3, 2009 in Business

Getting back into stocks has its risks, but so does sitting on the sidelines

Thomas Nihoul
 

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The world changed dramatically for U.S. investors on Oct. 10, 2008. The Dow Jones industrial average closed at 8,451, dropping more than 18 percent for the week – the worst on record.

In the panic, frightened investors began fleeing corporate stocks and bonds. The stampede from the market didn’t stop until March 9, 2009, when the Dow closed at 6,547.

Safety has a price

The panic of ’08 forced many investors to redefine risk. Some swore they would never again return to the markets. But those who stuck to that pledge have missed out on a 50 percent rebound since March 10. Instead of riding out the turbulent times by sticking to a financial plan and making gradual adjustments to their portfolios, panicked investors sold everything at extremely low prices. Then they stayed on the sidelines as the markets began to recover.

Opportunity cost

In an attempt to completely avoid risk, these all-or-nothing investors actually took on considerable risk – the risk of opportunity cost. Now these panicked investors who remain in short-term Treasuries are earning next to nothing on their money. And there is yet another risk to consider: inflation risk.

Inflation risk

As investors seek safety, liquidity and yield, they should also consider inflation risk – the possibility that the value of their savings will decrease as purchasing power is eaten away by rising inflation. Some investors might be tempted to seek higher yields from longer-term Treasuries. But these can become a trap if interest rates and inflation continue to rise.

Create a plan

To be sure, reinvesting in corporate stocks and bonds will expose investors’ money to the potential of more losses. But that is the risk required to earn the gains that prudent strategies and diversified investing can bring if given long enough to work. Consider speaking to an adviser about your investment goals, time horizon, and income and protection needs so you can create a financial plan that includes investment strategies that might be appropriate for you.

Tom Nihoul is a certified financial planner and member of the local Financial Planning Association chapter.


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