You don’t need to be a sailor to appreciate this metaphor — navigating your way through today’s volatile markets is a lot like sailing a boat through stormy seas. There’s little room for error, and you’ve got to keep on course to reach your destination.
After the kinds of markets we’ve seen, sea sickness comes to mind. When the stock market grows stormy, it’s natural for you to feel the urge to head for a safe harbor until the seas grow calmer. However, when investing for the long term, it’s usually best to keep sailing. I’ll explain why.
Just as a stormy sea can test a sailor’s endurance, skill, and patience, a volatile market tests the mettle of most investors. In this presentation, I’ll talk about why it’s best to stick by your long-term investment plan. I’ll also discuss some approaches, backed by historical market data, that can help you weather stormy markets, including: Adjusting your sails by adding an appropriate allocation to bonds. Staying invested to not miss out on the market’s investment potential over time. Keeping an even keel by making sure your portfolio is diversified across asset classes. And keeping your eyes on the horizon by taking advantage of opportunities today that may enhance your returns in the future. Diversification does not assure a profit or protect against loss. It is possible to lose money in a diversified portfolio.
In rough seas, a sailor will secure all the lines and adjust the sails to make sure the boat’s posture is in keeping with the current state of the ocean. As an investor during volatile markets, you need to do the same kind of safety and security check on your portfolio.
One of the patterns that has occurred over time in the markets is that when stocks are volatile, bonds are much more stable. This chart shows stock performance (in red) versus bonds (in yellow) over the past 10 years. You can see that bonds are steadier. They don’t usually go up as much when stocks are doing well or go down as much when stocks aren’t doing so well. In any given year, the return for stocks can be quite compelling, but the volatility is not for everyone. The moral of this story is that by adding bonds to your portfolio, you can smooth out volatility while still retaining some of the upside potential traditionally offered by stocks.
In the face of choppy investment markets, many investors have the urge to abandon ship, sell everything, and wait until conditions improve. While this urge is completely understandable, I’ll explain why acting on it can actually hamper your ability to reach your long-term goals.
By “waiting on the sidelines,” I mean investing in cash, such as CDs, T-bills, or money markets. What this chart shows is that today, cash is barely earning a positive return.
And it’s not just a recent phenomenon. Cash has barely kept pace with inflation over the past 80 years. The ability to grow and stay ahead of inflation is critical for long-term investors who need to accumulate savings during their working years and draw income from those investments when they retire. The fact is, stocks have delivered the greatest earnings power over the long term.
In volatile times for the stock market, many investors are tempted to move into conservative investments such as Treasury bills. However, their lower rates of return will prolong the time it takes for your account to recover. And, the greater the decline, the longer the recovery time — take a look at these scenarios. An investment with a 2% return after a market decline of 50% would take 35 years to recover. I think you would agree that most investors don’t have that much time.
Of course, most people don’t simply stay in those cash instruments forever. Typically, an investor who is nervous about volatility will move in and out of the markets, selling equities when they are going down and moving back in after they appear to be going up. However, this strategy has also proved costly to one’s long-term goals. The reason is timing. Let’s take a look at two investors — one who stuck with an investment plan through 20 years of changing markets, and one who shifted in and out of different mutual funds every few years. The investor who stayed fully invested would have earned almost twice as much as someone who moved in and out of funds. This chart illustrates the unfortunate reality that investors tend to sell after the market has fallen and buy after it has already rebounded. That’s the opposite of the “buy low, sell high” strategy we know is best. Time, not timing, is the best way to capitalize on the stock market’s gains.
Here’s something else you should know about the stock market: Often, a small number of strong days in the market make up a good deal of the performance over a longer period. For example, a few “up” days in a given year can account for most of that year’s total return. So if you happen to miss those days because you were waiting on the sidelines for the volatility to subside, you’d miss out on most of the market’s potential. This chart shows the effect of missing even a few days over the past 15 years. As it happens, there were 3,783 trading days in the past 15 years. By staying fully invested over the past 15 years, an investor would have realized a 6.63% annualized total return vs. a 1.97% return of someone who missed just 10 of the market’s days.
In sailing, a keel refers to the structure at the bottom of the boat that sticks straight down in the water. Ideally, you want the keel to stay pointed straight down because that means the boat will be steady. In investing, there is a common strategy used to help keep your portfolio on track without going into cash alone, and that strategy is called diversification. Diversification does not assure a profit or protect against loss. It is possible to lose money in a diversified portfolio.
This chart ranks the yearly performance of a wide range of investments, including value stocks, growth stocks, international stocks, and bonds. Each type of investment has its own color. The winners are on the top row, and the losers are on the bottom. Notice there is no pattern. Over 20 years, there have been 17 changes in market leadership. Often, the top-performing investment one year falls into the lower half in the next year. It is this unpredictability that can deter many investors. However, if you owned a greater number of these different types of investments in your portfolio — if you diversified — then it stands to reason that you would be more likely to own the best-performing investments in any given year. Note: U.S. small cap growth stocks are represented by the Russell 2000 Growth Index. U.S. large cap growth stocks are represented by the Russell 1000 Growth Index. U.S. small cap value stocks are represented by the Russell 2000 Value Index. U.S. large cap value stocks are represented by the Russell 1000 Value Index. International stocks are represented by the MSCI EAFE Index. U.S. bonds are represented by the Barclays Capital Aggregate Bond Index. Cash is represented by the BofA Merrill Lynch U.S. 3-month Treasury Bill Index.
This shows the indexes used to represent the asset classes on the preceding slides. U.S. small-cap growth stocks are represented by the Russell 2000 Growth Index. U.S. large-cap growth stocks are represented by the Russell 1000 Growth Index. U.S. small-cap value stocks are represented by the Russell 2000 Value Index. U.S. large-cap value stocks are represented by the Russell 1000 Value Index. International stocks are represented by the MSCI EAFE Index. U.S. bonds are represented by the Barclays Capital Aggregate Bond Index. Cash is represented by the BofA Merrill Lynch U.S. 3-month Treasury Bill Index.
But doesn’t that mean you’ll also own the losers? Yes. This is where diversification gets interesting. By owning more types of investments, you also own fewer of the losers each year since your money is spread out. So losses in any one area have less of an impact. This chart illustrates this point by showing the results of three strategies using investments in the asset classes shown on the previous slide. An investor who invested only in last year’s best-performing asset would have earned 5.45% over the full 20-year period. An investor who invested only in last year’s losers, figuring they were bound to go up, earned only slightly more: 5.53%. But an investor who invested consistently across all these various asset classes in equal proportion did the best, with an average return of 6.13%. Ironically, this strategy took the least amount of work. You didn’t have to figure out which were the best or worst investments each year, you simply bought a little of each and sat tight.
So now we know a little about the dangers of bailing out of the market during tough times, and we learned about the benefit of spreading your investment across a range of different types of assets, like value stocks, bonds, etc. There is one more area I’d like to discuss today, and that is the idea of keeping your eyes on the horizon, or in this case, your ultimate goal. To do this requires perspective to know that the long-term trend of the market will prevail over short-term events. Having that perspective is what enables successful investors to take advantage of investment opportunities that can come up from time to time. Let’s look at both aspects.
This chart shows the history of bull and bear markets since 1973. It shows both the duration of each event (from left to right), and it shows the cumulative return of each event (from top to bottom). Each bull and bear market in this slide is determined by at least four consecutive months of gain or decline. Over the past 63 years, there have been 13 bear markets, lasting an average of 14 months and declining a total of 24.2% before recovering. By contrast, the 13 bull markets since 1948 have lasted an average of 44 months, each growing an average of 120.6%. The moral of this story is that bull markets have always returned, and that they have outlasted the difficult times in the market.
A long-term investor who is confident in the market’s long-term prospects will naturally look for opportunities that arise from short-term events. If a clothing store has a going-out-of-business sale, that’s an opportunity to upgrade your wardrobe for less money. It’s not an indication that clothing is going out of style. So what’s on sale today as a result of the market’s volatility? Stocks. Everyone loved stocks in 1999, and investors bid up equity valuations to unprecedented levels. Today, there’s an interesting parallel to 1999. Since equity prices have fallen over the past decade even as companies earned record profits, stocks are unambiguously a better value today than in 1999 as measured by their price-to-earnings ratios. While near-term concerns could push stock prices lower, long-term investors should stay alert to the prospect of attractive valuations building in equities.
International stocks also represent an attractive opportunity in today’s market.
So those are some of the opportunities we see in the market today for investors who can keep their eyes on the horizon. To summarize today’s presentation, I would say that history and experience are your best guides in navigating through volatile markets. We’ve seen volatility before, and we’ll see it again There are ways (namely, by diversifying and adding bonds) to reduce the impact of that volatility Bailing on your long-term investment plan is counterproductive, as is moving in and out of the market Because we know that the volatile times don’t last, we can use them to our advantage as investors by buying investments “on sale.”
One more thing. You’re not in this alone. When it comes to managing your investments, Putnam believes that it’s best to consult with experienced professionals. That’s exactly the role of your financial representative. In addition, when you select a mutual fund for your portfolio, you also gain the professional expertise of the fund’s management.
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The stock markethas been choppyMonthly stock market returns (%) +10.93 +4.48 +4.32 +3.29 +2.96 +0.04 -0.22 +1.02 -1.13 -1.67 -2.03 -5.43 -7.03March March2011 2012Source: Standard & Poor’s. Stocks are represented by the S&P 500 Index, an unmanaged index of common stock performance.You cannot invest directly in an index. Past performance does not guarantee future results. EO077 275129 5/12 |2
How to weather the storm • Adjust your sails • Don’t abandon ship! • Keep an even keel • Keep your eyes on the horizonDiversification does not assure a profit or protect against loss. It is possible to losemoney in a diversified portfolio. EO077 275129 5/12 |3
When stocks were choppy,bonds were often stableAnnual market results (%) 40 U.S. stocks 30 20 10 0-10-20 U.S. bonds-30-40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011Data is as of 12/31/11 and is historical. Past performance does not guarantee future results. Stocks are represented by the S&P 500 Index,which is an unmanaged index of common stock performance. Bonds are represented by the Barclays Capital Aggregate Bond Index, anunmanaged index of U.S. investment-grade fixed-income securities. It is not possible to invest directly in an index. EO077 275129 5/12 |5
Cash yields are now near zeroCurrent yields as of 3/31/12 6-month T-bill 0.14% 6-month CD 0.50%Source: Federal Reserve, 2012. T-bills are represented by the 6-month Treasury bill (secondary market) rate quoted on an investment basis. CDsare represented by the 6-month Treasury bill (secondary market) rate quoted on a discount basis. Past performance is not indicative of future results.Unlike stocks or bonds, which incur more risk, certificates of deposit (CDs) offer a fixed rate of return, and the interest and principal on CDs willgenerally be insured by the FDIC up to $250,000. EO077 275129 5/12 |7
And cash has barely kept pacewith inflation over time 9.8%Returns for asset classes1926–2011 6.8% 5.7% 3.6% 2.7% 0.6%Returnsafterinflation Cash Bonds StocksSource: Putnam Investments. Returns are annualized and assume a historical average inflation rate of 3%. Stocks are represented by the S&P 500Total Return Index. Bonds are represented by the Long-Term Government Bond Total Return Index. Cash is represented by the U.S. Treasury BillIndex. All indexes are unmanaged and measure common sectors of the stock and bond indexes. You cannot invest directly in an index. Pastperformance is not indicative of future results. EO077 275129 5/12 |8
How long does it take torecover from a downturn?In an economic downturn with a 50% loss in themarket, it would take you 35years to recover yourinvestments if you earned 2% per yearIf you earned 10% per year, you would recoveryour investment in 7 yearsThis hypothetical illustration is based on mathematical principles and assumes monthly compounding. It is not meant as a forecast of future events oras a statement that prior markets may be duplicated. EO077 275129 5/12 |9
Investors who shifted in andout of the market have suffered20-year annualized returns1987–2007Buy and hold20-year investment 11.8%in the S&P 500Average equityfund investor 4.5%holding various fundsfor just over 3 yearsSource: DALBAR, Quantitative Analysis of Investor Behavior, 2008. Study is based on data as of 12/31/07, which is the most recent dataavailable. The average equity fund investor’s portfolio is composed of 95% domestic equity and 5% domestic fixed-income holdings.Past performance does not guarantee future results. There are no guarantees that prior markets will be duplicated. The S&P 500 Index is anunmanaged index of common stock performance. It is not possible to invest directly in an index. EO077 275129 5/12 | 10
Missing even a few of themarket’s best days can hurtInvesting $10,000 in the Dow Jones Industrial Average15-year period, 12/31/96–12/31/11If you stayed fullyinvested for 15 years 6.63%If you missed the market’s10 best days 1.97%If you missed the market’s20 best days -1.05%Data is historical. Past performance is not a guarantee of future results. The best time to invest assumes shares are bought when market prices are low.The Dow Jones Industrial Average is an unmanaged index of common stock performance. Indexes assume reinvestment of all distributions and do nothave a sales charge. It is not possible to invest directly in an index. The securities in the Putnam funds will differ from those in the index, and the funds’performance will differ. EO077 275129 5/12 | 11
Diversify to own moreof each year’s winnersChanges in market performance, 1991–2011 1991 1996 2001 2006 2011HighestreturnLowestreturn U.S. small-cap growth stocks | Russell 2000 Growth Index International stocks | MSCI EAFE Index U.S. large-cap growth stocks | Russell 1000 Growth Index U.S. bonds | Barclays Capital Aggregate Bond Index U.S. small-cap value stocks | Russell 2000 Value Index Cash | BofA Merrill Lynch U.S. 3-month Treasury Bill Index U.S. large-cap value stocks | Russell 1000 Value IndexPast performance does not indicate future results.Indexes are unmanaged and show broad market performance. It is not possible to invest directly in an index. EO077 275129 5/12 | 13
Small-cap growth stocks are represented by the Russell 2000 Growth Index, which is anunmanaged index of those companies in the Russell 2000 Index chosen for their growthorientation.Large-cap growth stocks are represented by the Russell 1000 Growth Index, which is anunmanaged index of capitalization-weighted stocks chosen for their growth orientation.Small-cap value stocks are represented by the Russell 2000 Value Index, which is anunmanaged index of those companies in the Russell 2000 Index chosen for their value orientation.Large-cap value stocks are represented by the Russell 1000 Value Index, which is anunmanaged index of capitalization-weighted stocks chosen for their value orientation.International stocks are represented by the MSCI EAFE Index, which is an unmanaged indexof international stocks from Europe, Australasia, and the Far East.U.S. bonds are represented by the Barclays Capital Aggregate Bond Index, which is anunmanaged index used as a general measure of fixed-income securities.Government bonds and Treasury bills are guaranteed by the U.S. government and,if held to maturity, offer a fixed rate of return and fixed principal value.Cash is represented by the BofA Merrill Lynch U.S. 3-month Treasury Bill Index, which is anunmanaged index used as a general measure for money market or cash instruments. EO077 275129 5/12 | 14
Diversify to own fewerof each year’s losersAverage annual total return on $10,000, 1991–2011 Investing in last year’s best-performing asset class 5.45% Investing in last year’s worst-performing asset class 5.53% Investing consistently across several asset classes 6.13%Diversification does not assure a profit or protect against loss. It is possible to lose money in adiversified portfolio. Past performance does not guarantee future results.The asset allocation scenario represents an investment allocated equally across all seven indexes shown on slide 14. You cannot invest directly in anindex. This analysis has been figured on an annual basis and does not reflect rebalancing. EO077 275129 5/12 | 15
Keep your eyeson the horizon EO077 275129 5/12 | 16
The storm has always passed Bear market Bull marketJanuary December1973 2011Markets are represented by the S&P 500 Index.Data is as of 12/31/11, is historical, and reflects reinvested dividends. Each bull or bear market is determined by at least four consecutive months ofcontinuous gain or decline. Past performance does not guarantee future results. There are no guarantees that prior markets will be duplicated.The S&P 500 Index is an unmanaged index of common stock performance. It is not possible to invest directly in an index. EO077 275129 5/12 | 17
Stocks are priced attractively 2000 26.8 today Price-to-normal- earnings ratio of the U.S. stock market* 2011 15.9* As measured by the S&P 500 Index. Data as of 12/31/11. Current price to earnings is a ratio equal to the market capitalization divided by its after-tax earnings, based on 12 months’ trailing earnings. EO077 275129 5/12 | 18
International stocks are even more 2000 26.8 attractive Price-to-normal- earnings ratio of U.S. and international 2011 stock markets* 15.9 International stocks 2011 13.0* As measured by the S&P 500 Index. Data as of 12/31/11. International stocks are measured by the MSCI EAFE Index. Current price to earnings is a ratio equal to the market capitalization divided by its after-tax earnings, based on 12 months’ trailing earnings. International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. EO077 275129 5/12 | 19
Benefit from those who have gone before you• Market volatility is inevitable• There are ways to lessen the impact• Abandoning your plan is counterproductive• Remember, bull markets have always returned• Take advantage of today’s opportunities to improve your portfolio EO077 275129 5/12 | 20
Hire an experienced crew• Your financial advisor• Putnam Investments EO077 275129 5/12 | 21
A BALANCED APPROACHA WORLD OF INVESTINGA COMMITMENT TO EXCELLENCE EO077 275129 5/12 | 22
Investors should carefully consider theinvestment objectives, risks, charges, andexpenses of a fund before investing.For a prospectus, or a summary prospectus ifavailable, containing this and other informationfor any Putnam fund or product, call yourfinancial representative or call Putnam at1-800-225-1581. Please read the prospectuscarefully before investing.Putnam Retail Managementputnam.com EO077 275129 5/12 | 23