Focus on Personal Finance
Investing After a Financial Shock
Sept. 11 changed the outlook for investors -- but for how long?

We're deeply saddened by the tragic events surrounding the terrorist attacks on the World Trade Center and the Pentagon. At the same time, the financial repercussions now being felt around the world have created tremendous uncertainty in the minds of investors, raising questions and concerns that we believe need to be addressed.

With these tragic events representing one of the most significant financial shocks in the past 100 years, we want to use this month's column to help you assess the overall investment outlook, and to understand how it relates to your own financial situation. We also want to examine where the economy and the financial markets may go from here.

WHAT HISTORY TELLS US

The U.S. stock market initially reacted very negatively when it was allowed to reopen on Sept. 17. Historically, this type of "shock" decline is typically followed by gradual stock price improvement. This type of market behavior can be confirmed by studying extreme economic shocks since the fall of France in 1940.

In a strong economy, the prudent strategy for all investors would be to use any dramatic market decline as a buying opportunity. And until Sept. 11, we were fairly confident of an economic recovery at some point in the first half of 2002. Anticipation of an economic recovery typically boosts stocks in the 4 to 6 months prior to the start of the recovery, but that scenario no longer applies.

Now our question is: How will the consumer react to the terrorist action? If consumers don't cut back on their spending, then any severe market weakness presents a buying opportunity. But if consumers lose confidence, any economic recovery will be pushed off to some undetermined time and prolong the period of market weakness. Recent reports suggest that consumers have indeed lost some confidence in the near-term prospects for the U.S. economy.

Another important question is: With the economy now sinking into recession, how long and how deep will the slowdown be? That will depend on how effective the sharp reductions in interest rates, tax rebates and any other government stimulus programs -- such as further tax cuts -- will be in reversing the current negative atmosphere.

WHERE DO WE GO FROM HERE?

In terms of your individual portfolios, we don't recommend exiting the stock market now. The biggest financial losses were actually incurred just after the terrorist attacks. Emotions ruled that first selling wave.

It takes a disciplined investor to continue to dollar-cost-average in the worst of times. But there will be a better day. History (the only thing we have since we don't have a crystal ball) suggests that the markets will amply reward investors for patience and discipline during these gut-wrenching times. If you have a long-time horizon, say 5 to 10 years, your portfolios should be fine. Stay the course. If your time horizon is less than 5 years and you're fully invested in stocks, your asset allocation is too aggressive. You need to work with an investment adviser to build a more diversified portfolio.

THINK LONG TERM

We encourage you to remain focused on your long-term goals and objectives. The short-term environment will continue to be difficult, but the U.S. stock market will remain one of the best vehicles for long-term asset appreciation.

We have immense confidence in the basic strength of the U.S. economic system. If you maintain a long-term view that's based on a diversified asset allocation strategy, your confidence in the U.S. economic system should be handsomely rewarded in the long run.

You probably will have to endure a great deal of volatility along the way, but your journey to financial independence is a long and winding road. Stick to your road map, and you should be fine. 

Richard J. Alphonso, JD, CPA/PFS, M.S.T., and Steve A.. Estrin, MBA, are president and chairman, respectively, of The Financial Advisory Group, Inc., in Houston. The Financial Advisory Group provides personalized fee-only financial planning, investment management and business consulting services.