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Plan Well, Retire Well

Saving and investing your money
StdDevofDailyClose 2000to2008 monthlybasis jpeg

Risk and your investments

Our Plan Well, Retire Well team recently ran a series of teleconferences for the average investor and saver titled "Saving and Investing in Turbulent Times." In the teleconference I spoke about the risk and how the market's volatility increases as we go into a period of adjustment and market decline. I used a graph of the standard deviation (a statistical measure of variation or dispersion) by month of the daily close of the Dow Jones Industrial Average for the time period of January 1, 2000 through December 10, 2008.

In this graph, the standard deviation is simply a measure of how dispersed the market close of the DJIA is over a month. The month 480 on the x-axis refers to January 2000.

To me there are several take away lessons and messages from this graph. First, in previous investment downturns (such as the early 2000s in the graph) we have seen levels of volatility that are similar to what we have experienced in the past year. Second, it raises the question of what level of risk do people have in mind when they are planning and allocating their investments. When a person does his or her investment allocation does he or she expect to see the historic highs in terms of market variability? If we are making allocation decisions in a period of relatively low market variability do we tend to assume things will continue this way going forward? A third question is whether the markets are now fundamentally more risky than they were previously. The graph doesn't answer this specific question but it shows the high levels of market fluctuations we have experienced in the last year.

Two other lessons come out from the graph with implications for savers and investors. First, making sure your investment allocation can handle a period of significant market fluctuations (and the implied drops) is important. Many investors find a tool like a ladder of bonds that will mature at different dates to be a good way to build in some of this cushion so that they do not need to drawn down their equities while the market is down. Second, taking a long-term view of the markets and their capability for fluctuations is important and reinforces the need for rebalancing portfolios periodically (for many of us about once a year).

We'll be doing another teleconference in April of 2009. Please keep an eye for more information related to venues where you can participate in the teleconference workshop.

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