The stock market has lulled us all into thinking the only way it can go is up!  After all, last year the market punched up through 14,000, and 15,000, and then 16,000 without much of a pause.  But now that we’ve seen a few weeks of both volatility and downside, it’s time to reconsider both your hopes and your fears for the stock market in the year ahead.

Let’s start with some long-term perspective.  It’s a fact, researched by the Ibbotson market historians, that there has never been a 20-year period where you would have lost money in a diversified portfolio of large American companies, with dividends reinvested – even adjusted for inflation.  That statistic goes back to periods starting in 1926, and includes every 20-year period since then, even the depression years of the 1930s and even through the most recent market declines.

So, if you are investing for the long run in your retirement account, you should continue to contribute to that stock investment, typically a Standard and Poors 500 Index fund, which is included in every retirement portfolio.  You need to make that monthly contribution when the market is falling and you’re scared that the bottom will fall out, and when the market is rising and you’re scared that you’re too late to invest.  Over the long run, all you need is the discipline to stick with the plan.

After all, if things are really different this time, and America does not survive economically, you’ll have far more to worry about than your retirement account!

Chicken Money

But as you grow older, your perspective changes.  Suddenly, you realize that you might not have the fortitude to ride out a bear market – especially since you are likely to need some of that money to live on during the next 20 years.  You don’t want to be forced to sell during a bear market.

That’s why you diversify your assets, including some safe “chicken money” assets where you are guaranteed not to lose, and have guaranteed liquidity.  That’s the money that lets you sleep at night with your volatile investment portfolio.  It’s money that belongs in a bank money market deposit account, or short-term CDs, or a money market mutual fund, or directly invested in Treasury bills.

Of course, you’ve spotted the hazard immediately.  Today, those kinds of chicken money accounts pay little or even no interest!  Savers are a victim of the Fed’s low interest rate policies, allowing the government to borrow at a very low cost.  If you stick with your chicken money investments, you aren’t even keeping up with inflation – especially the inflation that hits seniors the hardest in rising medical costs.

But if it’s truly money you’ve set aside for financial security in a balanced allocation of your assets, you must resist the temptation of seeking higher yields.  Those higher yields only come with costs – many of them hidden.  Either you can’t get out easily (surrender charges, illiquid markets) so you’re stuck when rates do start to rise.  Or, you’re taking on more risk – even if it isn’t readily apparent – such as the risk that bond prices will fall when interest rates rise.

When short term risk-free rates are near zero, as are 90 day Treasury bills currently yielding 0.04 percent, then any higher return implies more risk.  Keep that in mind as you worry about the stock market, but complain about low yields.

The Outlook in A Mid-Term Election Year

The best perspective on the stock market performance in mid-term election years comes from Jim Stack’s Investech Research Newsletter (www.investech.com).   Since starting the newsletter 33 years ago, Stack has consistently ranked among the top 10 in the Hulbert ratings of annual and long-term newsletter performers.

Stack is a market historian.  In his latest issue, he points out that the first nine months of a mid-term election cycle are typically very volatile, and have often produced losses.  BUT, the fourth quarter of a midterm election cycle has averaged a gain of 7.8 percent, and that in the fourth quarter the S&P has finished higher 90 percent of the time!  These statistics go back to 1940, so it is a well-established pattern.  And it means this could be a very interesting year for the market.

Stack’s advice has helped those who want to trade the large market movements as opposed to simply buying and holding over the long run.  In his latest issue he notes that over the past 82 years, there have been 15 bull markets.  The average duration or life span of the previous bull markets has been 3.8 years.  So we are already a full year past the average bull market!

Still, Stack remains “cautiously optimistic” about the market in the year ahead – especially given those fourth-quarter, post mid-term election statistics.    Stack’s other proprietary indicators are worth watching if you want the discipline to try to call market turns following his advice.  (A subscription is $295/year at 406-862-7777.  And in the interest of full disclosure, yes I receive a complimentary copy.)

But you don’t have to trade the market to be a successful, long-term investor. Warren Buffet has pretty well proved that point.  All you have to do is have the discipline to pick a strategy – and stick with it.  The biggest losses come when emotion overrules discipline.  And that’s The Savage Truth.