Statistics Offer Investors Hope in 2003

The miserable performance of the stock market in 2000, 2001, and this past year has marked one of the steepest declines in more than 6 decades. In addition, the broad market gauges (ie, Dow and S&P 500) wrapped up their first 3-year string of declines since World War II. So will 2003 offer investors another rocky year or will the market improve and provide better days? Let's take a look at the past year before looking ahead.

A YEAR IN REVIEW

Do you remember the 1970s? Well, the last time the Dow suffered a loss as great as it did this past year was in 1977. Unfortunately, since the Dow reached its record high of 11,721.98 on January 14, 2000, it has been down nearly 29%. This past December alone, the Dow was down 7%—its worst December performance since 1931.

But that wasn't the only index to suffer in 2002. All sectors in the S&P 500 index were down this past year too—the first time this has happened since 1981, when it began tracking such data. This past year, the S&P 500 lost about $2.4 trillion in market value (since the 3- year bear market began in 2000, the S&P has lost a total of $4.3 trillion) and fell almost 24%. In addition, the technology-laden Nasdaq fell nearly 31% in 2002.

All 3 market barometers, the Dow, the S&P 500, and the Nasdaq, slid to multiyear lows on October 9, 2002—a 6-year low for the Nasdaq and 5-year lows for both the Dow and the S&P 500. Since that time, the markets have rallied, paring some of the year's losses. And by year-end, the Dow had rebounded about 14%, while the S&P 500 rose 11% and the Nasdaq rose nearly 17%.

FUTURE ASSET ALLOCATION

So, what should investors expect in 2003? Since the inception of the Dow back in 1896, there have been only 3 other time periods when the markets have suffered 3 or more years of back-to-back declines: 1901 to 1903, 1929 to 1932, and 1939 to 1941. And in each case, the fourth or fifth year after the declines has been the turnaround year. In 1904, the market rebounded nearly 42%. In 1933, after a 4-year period of declines, it rebounded a dramatic 67%. And in 1942, the market managed to rebound nearly 8%. Basing predictions on historical statistics, 2003 should be a pretty good market year.

However, whether or not you believe the statisticians or the economists, it's a good idea to develop a prudent investment strategy whose time horizon meets your financial expectations. In addition, you should aim to create an investment strategy that can withstand both a good market year and a bad market year (just in case history does not repeat itself).

IN THE DOLDRUMS

Unfortunately, I have found that many investors are now down anywhere from 30% to 50% on their investment portfolios. Some investors are down even more because of a weak investment strategy. Could these portfolio losses have been avoided? The answer is, most definitely, yes. Utilizing some common sense, investing prudently, and adhering to the strict discipline of asset allocation, there is no reason why an investor should have lost half their investment portfolio.

THE PORTFOLIO'S FATE

To better illustrate how investors could have prevented losing half their investment portfolio by utilizing asset allocation, consider the following portfolio example. For the month ending November 11, 2002, the 12- month return on the S&P 500 was -16.51%, and the 3-year compounded annualized rate of return was -11.13%. Similarly, the Dow registered a 12-month return of -10.42%, and a 3-year compounded annualized rate of return of -5.37%.

Using an asset allocation approach, I constructed a balanced portfolio comprised of 50% domestic (US) equity, 10% international equity, and 40% fixed income. I then broke the portfolio down: 17% large cap value, 17% large cap growth, 10% large cap international, 8% small cap value, 8% small cap growth, 20% short-term high-quality fixed income, and 20% intermediate-term fixed income. In addition, I selected only mutual funds for my portfolio that had a 3- year track record and that ranked in the top quartile of their asset class category for the 3 previous years. The constructed portfolio's results appear in the table above.

SO MANY OPTIONS

Admittedly, based on the number of funds in each category, there was quite a number from which to choose. I simply took the averages in each category without even selecting the better performing funds. I might also add that these results would have yielded a portfolio with a great deal less risk than the overall risk involved with holding the market portfolio (ie, S&P 500). So talk with your financial advisor if asset allocation interests you. They will be able to steer you in the direction that's right for your situation this year, which will hopefully be a good one for both the market and investors.

Thomas R. Kosky and his partner, Harris L. Kerker, are principals of the Asset Planning Group in Miami, Fla. Mr. Kosky teaches corporate finance in the Saturday Executive and Health Care Executive MBA

Programs at the University of Miami. and welcomes questions or comments at 800-953-5508. For more information, visit www.assetplanning.net.