Lessons learned from five years of volatility

by Bill Blevins, Financial Correspondent
Blevins Franks International Limited


The last couple of years in the financial world might not have been the healthiest, but the prognosis isn’t all bad, and, if nothing else, we’ve leaned some useful lessons. I think it’s time for a check-up. As the market apparently pauses to assess where it is headed next, this is a good opportunity to stop, look back and examine these lessons. Surely we must have learned something. After all, we went through:

An unprecedented 27.6%-a-year gain in stocks from 1997 to 1999, followed by an annual decline of 10.5% for two years — the second-worst two-year period for stocks since 1945 (as measured by Standard & Poor's 500 index).

An average 16% gain in foreign funds from 1997 to 1999, followed by an annual fall of 17.4% for the next two years — the second-worst period for international stocks since 1970 (as measured by the MSCI-EAFE index).

Bonds moving from a 6.1% annual return in the 1997-99 period to 10.1% a year in the next two years — the 11th-best period for these fixed-income investments since 1945 (as measured by Ibbotson Associates' U.S. Intermediate Term Government Bond Series).

You will recall that back in 1999 we were hearing phrases such as "Long live the bull" and "Stocks don't go up because they have a specific value." We are now all a lot wiser than that. Here's a checklist that might help us keep track of what we have learned.

Market cycles do exist

Remember those who said in 1998 and 1999 that market cycles had ceased to exist? We had entered a new economy, they suggested. That economy was headed ever upward, with only a slight hiccup along the way. As the markets soared and then slumped, we learned the hard way that cycles certainly continue to exist.


All trends do end

Those who saw the dominance of technology stocks as virtually an eternal trend, know today that the trend is over. At least for a while. Also, who could guess in 2000 that real estate would prove to be the best performing asset class in the following couple of years? Who predicted that fixed income would be so strong?

We have been reminded anew that trends start and trends end. We just don't know in advance when they will do so, what form they will take, and how long they will last.

Return and risk are related

Back in 1999, many were acting as though investing in stocks was risk-free. With annual gains of 20% to 30% for a few years, a common approach can be summarised in these comments taken from publications at the time, "As for risk ... ha! That's for wusses" and "Sometimes the biggest risk you can take is trying to play it too safe."

Now we have all learned again that those tables that put stocks on the riskier end of the investment spectrum are right, after all. Greater return indeed comes at a price. Over the past five years, the lesson also seemed to be that the greater the return, the higher the risk and the bigger the payback.

Diversification is important

It became popular during the latter part of the '90s to consider diversification unnecessary. All you needed to do was invest in stocks, particularly growth stocks. Sure, they might have a down period now and then, investors figured, but overall they were set to rocket in value year after year.

Who needed bonds? As the writer of an article for a financial magazine expressed it in 1999, "The mere suggestion you should even put a cent of your money in bonds is met with incredulous stares." The writer went on to suggest that bonds still had a role to play in every investment portfolio, but chances are that his advice fell on many deaf ears. Now we know from experience that bonds indeed have a role to play in any balanced portfolio.

So how should we put these investment lessons into practice?

One way is to look back on what happened to those who, in the late '90s, did not follow the fashion, but remained true to the principles of diversification.

To ensure we are ready for the next market cycle and the beginning of a new trend, investors should remain diversified. Even though we do not know what those cycles or trends will be or when they will start, we know they likely will occur — and diversification ensures we are prepared.

Investors need also to balance return and risk, aware that strong returns can be followed by a payback time. Above all, remember, if historical patterns hold, that the next cycle will rise and fall and a new one eventually will take its place, the new trend will not last forever, and risk remains related to return.

It takes discipline to stick to these principles, particularly when the rest of the world seems convinced that the new trend is here to stay. But if you apply that discipline you may be more effectively positioned for the twists and turns that lie ahead.

If you would like fuller details of how to save tax in France see our website at http://www.blevinsfranks.com and then contact the Partner of the Firm nearest to your French place of residence.

Ask us anything, we will do our best to help. Write to us with our ...

Get a recent copy of the newsletter -