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Is the Sky Falling?

The headlines have been shouting at investors:
  • Unemployment is soaring.
  • Our budget deficits and trade deficits are spiraling out of control.
  • Social Security and other entitlement programs are going to bankrupt the country.
  • The dollar is collapsing and is about to lose its status as the world's reserve currency.
  • Gold is skyrocketing.
  • The U.S. is losing its status as the world's industrial leader, with an Asian country set to overtake it.
Though the above headlines could have been from today's news, they were taken from the period around 1980. (The only difference is that then it was Japan and now it's China.) As we know, the U.S. economy overcame the severe problems it faced, and the U.S. equity market went on to have the greatest bull run in history. For the 20-year period from 1980 through 1999, the S&P 500 Index returned almost 18 percent per year.

Despite the lessons from history, these headlines still put a great scare into most investors. In fact, despite the great rally the equity markets have experienced since March, equity mutual funds have actually experienced net outflows this year. On the other hand, taxable bond funds attracted more than $250 billion and municipal bond funds about $60 billion.

The evidence on cash flows is another example of history repeating itself. Investors have persistently demonstrated that they're their own worst enemy. They invest as if they were driving using rear view mirrors: buying after bull markets and selling after bear markets. The result is that investors have persistently underperformed the very funds in which they invest.

I'm certainly not saying history will repeat itself in terms of future stock returns. And as much as we would like to think otherwise, there really are no good forecasters. Thus, you should focus on what you can control: the types and amount of risk you take, costs and tax efficiency.

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