It is Quarterly Report Time

It is the end of another quarter and investors are receiving their third-quarter reports.  Some will see a gain year to date and believe they have made money.  Others, depending on allocation or holdings may see a decline and believe they have lost money year to date.  I would respectfully disagree with both.  As I have said in the past, I would suggest the only time any investor makes or loses money on any investment is when it is sold.  The reports investors are reviewing reflect the value of the holdings or portfolios on September 30th and the gain or loss for the reported time period.  Keep in mind, since the 30th the values and gains or losses have already changed. 

This is a good time to think about emotional responses to financial events.  In 1987, reports for the third quarter dated September 30th looked pretty good.  A few weeks later, the stock market as measured by the S&P Index declined almost 23% in one day, the largest percentage decline in stock market history. 

September 30th, 1999, investors were very pleased reviewing their third-quarter reports.  Three years later, the stock market, again measured by the S&P Index, had declined almost 40%.  September 30th, 2007, would lead to a similar story. 

In each of these time periods, investors who were pleased with their "gains" after reviewing their third-quarter report and then later sold their holdings during the decline turned a paper loss into a realized one.  This is one of the reasons the "average investor" has consistently under-performed stock market averages.  In each of the above referenced time periods, investors who did not sell, eventually saw the market values which had declined eventually recover.  

I do not know if the stock market is going to decline in the near future.  I do believe the stock market will decline significantly at some point in the future, maybe the next few months, maybe years from now, but I believe it will happen.

Each investor, when they look at their reports, now or in the future should be asking themselves if a significant stock market decline will affect their portfolio and if so, how they will respond to the decline.  In so doing, they should be honest about how they have responded to past declines. As part of this, an individual investor who responded to the decline in 1987 one way, may react differently to the same decline today because circumstances are different.  Now is the time to think about this, not during or after it has happened.  

I would suggest investors when looking at their reports, should multiply the current market value of their equity holdings by 70% which would equate to a 30% stock market decline.  Write down this new theoretical value and think about the emotional and financial response.   

At the same time, I would suggest investors do the following:

• Compare their desired return to the expected return.  
• Review historical worst time periods for the current allocation or investment strategy.  I believe this is much more important and valuable information than the historically best time periods for a given allocation or investment strategy.  Though neither predicts the future, the emotional response to reviewing gains is much different than reviewing declines. 
• Identify and write down cash needs including the amount and when needed.  This could include anything from an annual withdrawal for income needs to buying a different car in two years.  Then make sure funds needed for these withdrawals are invested in minimal or low-risk accounts.  

In short, when reviewing the most recent statement, be proactive about going forward.  This does not mean necessarily changing anything.  It does mean thinking about long term investment objectives and risk-reward strategy.