Investment Colly-Wobbles

Yesterday walking through DreamWorks, I got asked about Tuesday's stock market meltdown, and its impact on TAG's 401(k) Plan. My response?

"Ah, probably not good, if you were heavy in stocks. But probably less bad, if you were weighted toward bonds." (This particular animator wasn't heavily invested in bonds. Which explained his question to me. And long face.)

I spent a couple of minutes explaining investment strategies; they boil down to this:

There's a magical investment philosophy called the Efficient Frontier. Boiled down, the EF is: the most return from your investment dollar with the least risk. (It was sort of invented by Markowitz and Sharpe, who got Nobel-laureated for their work in this area.)

Of course, miminizing risk and maximizing return is easier said than done, because the EF is a moving target: what gets you the most return with the least risk can change from year to year, month to month, week to week. That's why trying to time the market is such a major bitch. You don't know where the market will be going on any given day, because you don't know where the economic world (or just plain world) is going. Doctors M. and S. figured that a 50/50 split was pretty close to ideal (if my memory serves.)

Naturally, sometimes it's a little different, but we give it our best shot based on historical models, since Merlin and his crystal ball aren't currently in the building.

Directly below I've helpfully listed various investment models, courtesy of the Vanguard Group. These models assume wide diversification of both stocks and bonds. (Real estate investment trusts aren't in the mix, but they behave differently than garden-variety stocks.)

100% Bonds

Historic risk/return (1960-2005)

Average return 7.1%

Best year 31.1% (1982)

Worst year –8.1% (1969)

Years with a loss - 5 of 46 (10.9%)

80% Bonds / 20% Stocks

Historic risk/return (1960-2005)

Average return 8.0%

Best year 28.6% (1982)

Worst year –8.2% (1969)

Years with a loss - 5 of 46 (10.9%)

70% Bonds / 30% Stocks

Historic risk/return (1960-2005)

Average return 8.4%

Best year 27.4% (1982)

Worst year –8.4% (1974)

Years with a loss 5 of 46 (10.9%)

Balanced

A balanced-oriented investor seeks to reduce potential volatility by including income-generating investments in his or her portfolio and accepting moderate growth of principal, is willing to tolerate short-term price fluctuations, and has a mid- to long-range investment time horizon.

60% Bonds / 40% Stocks

Historic risk/return (1960-2005)

Average return 8.7%

Best year 26.1% (1982)

Worst year –11.3% (1974)

Years with a loss 6 of 46 (13.0%)

50% Bonds / 50% Stocks

Historic risk/return (1960-2005)

Average return 9.1%

Best year 27.8% (1995)

Worst year –14.1% (1974)

Years with a loss 8 of 46 (17.4%)

40% Bonds / 60% Stocks

Historic risk/return (1960-2005)

Average return 9.4%

Best year 29.6% (1995)

Worst year –17.0% (1974)

Years with a loss 11 of 46 (23.9%)

Growth

A growth-oriented investor seeks to maximize the long-term potential for growth of principal, is willing to tolerate potentially large short-term price fluctuations, and has a long-term investment time horizon. Generating current income is not a primary goal.

30% Bonds / 70% Stocks

Historic risk/return (1960-2005)

Average return 9.7%

Best year 31.3% (1995)

Worst year –19.8% (1974)

Years with a loss 12 of 46 (26.1%)

20% Bonds / 80% Stocks

Historic risk/return (1960-2005)

Average return 10.0%

Best year 33.2% (1975)

Worst year –22.7% (1974)

Years with a loss 12 of 46 (26.1%)

100% Stocks

Historic risk/return (1960-2005)

Average return 10.5%

Best year 38.5% (1975)

Worst year –28.4% (1974)

Years with a loss 12 of 46 (26.1%)

© 1995–2007 The Vanguard Group, Inc.