A Longer View Smooths Out Market Spikes

To see why so many advisors urge a patient, long-term approach to investing, look at the up-and-down numbers game played out on Wall Street over the last few weeks.

The April report on inflation was worse than expected, and stock prices plunged. Then the May consumer price index came in better than expected, and they soared.

Here’s a warning: By some analysts’ preliminary reckoning, the CPI increase for June looks as though it might jump back to a scary level. Could the market tumble again?

From the stock market’s day-by-day reactions to each statistical announcement that comes along, you get an impression of investors in a frantic scramble to keep up as the world spins faster and faster.

But if you take a slightly longer perspective, the zigs and zags on the charts lose some of their sharp edges, and the game looks a little more rational. Instead of an impossible melee, the market presents itself as a reasonable, even though absolutely unpredictable, place in which to take calculated risks with your money.

As of late last week, the popular stock indexes showed year-to-date gains of 5% to 20%, depending on the sector of the market they measure. The Dow Jones industrial average stood just slightly above where it was two months ago.

That’s a very good showing--double-digit gains all around when you project them out to annual rates--in keeping with an economy that is still bursting with signs of vitality.

Later this month, the Federal Reserve may well push short-term interest rates higher in an effort to cool down the economy. The markets, which always anticipate, seem almost to have worn themselves out discounting every possible choice the Fed might make and now stand not far from where they were before the whole inflation scare arose.

It has proved not only futile, but also unnecessary, for investors to figure out each twist and turn of the story.

“How long will the current short-term desire to buy stocks last? We have no idea,” says George Putnam III in his Boston-based Turnaround Letter. “Given the diversity of the group who currently want to buy stocks, it is virtually impossible to predict what will make them change their minds and when it will happen.

“Fortunately for our reputation, we didn’t advise anyone to get out of stocks two years ago when the Asian crisis broke or last summer when Russia’s economy imploded. And we are not going to do so now, even though we are quite concerned about rising interest rates.

“Successfully anticipating stock market movements requires not only that you correctly forecast world economic trends and events, but also that you predict the reactions of a large and diverse group of human beings. We certainly can’t do both of those, and we don’t know anyone who can.”

Once you decide not to try to outguess the economic data or the markets, the question naturally arises: What are you going to do to protect yourself from long bear markets and other calamities?

The time-honored answer is to diversify, keeping your money spread out to minimize the potential damage from disaster in any one stock, mutual fund or market, for that matter.

Now is a great time, for instance, to have some money in the stock market, and some money not in the stock market. Also to keep money that is earmarked for interest-bearing securities diversified between long-term bonds and the short-term money markets.

That way your overall portfolio won’t be knocked off balance regardless of whether the Fed tightens credit conditions.