Most economists believe the economy will start improving in the latter portion of 2009. Even the most pessimistic of the lot grudgingly agree that clear signs of recovery should start appearing by mid-2010.

So where does that leave all of those supposedly long-term-focused investors who panicked and already bailed out of their stock exchange-traded funds?

First of all, they should recognize that as more bad news arrives in the coming months—and there will be, rest assured—there’s a somewhat predictable nature to rebuilding an economy.

The good news about the past bear market is that its root causes are quite apparent. It just makes sense to logically establish a foundation to fix the problem areas, which many world economies and corporations are currently doing.

Also, it is important to remember that corporate layoffs are the first sign of recovery and that unemployment typically peaks toward the end of a recession. In order for corporations to return to profitability, cost cutting is necessary. Once cost is reduced, then companies can return to profitability and continue to grow.

Setting Priorities

I have never heard of or met any professional or amateur who has ever been consistently right in predicting the investment markets. You might have heard the numerous studies that prove more than 90% of your performance (through both up as well as down markets) is based on asset allocation—and less than 10% of your performance is based on market-timing and security selection (including investment manager selection).

If such a small percentage of your overall return is caused by market-timing, then why do so many investors choose to move in and out of markets? The two primary reasons are greed and fear, neither of which should play a part in your investment plan.

Research firm Dalbar Inc. has completed a long-term market-timing study. Based on an analysis of investor behavior between 1987-2007, the average growth mutual fund investor earned just 4.48%, while the S&P 500 stock market index averaged 11.81%.

During the same 20-year study, the Barclays Aggregate Bond Index (formerly Lehman) averaged 7.56%, while the average bond fund investor only earned 1.55%.

It is staggering to realize that the average growth fund investor under-performed the broad stock market by over 7% and that the average bond fund investor under-performed by over 6%.

Why would investors under-perform by such a wide margin compared with the broad markets? The answer, according to the Dalbar study, is market-timing.

Even though the study stated that investors guessed right 61% of the time, the 39% of the time that investors guessed wrong had a stronger negative impact on their overall performance.

Interestingly, during periods of “irrational exuberance,” (such as the late 1990s), the percentage of time investors guessed right declined dramatically.

Obviously we are in another period of “irrational exuberance.”

Even as of June 30, the U.S. stock market was deeply undervalued. The trick to successful investing given the unknown is actually quite simple: Stay the course.

1 | 2 |