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Keeping Your Portfolio in Perspective During Tough Times

It was, to say the least, a volatile year for retirement investors. The September 11 terrorist attacks rocked the financial markets. Economic forecasts remain uncertain. For the better part of 18 months, the stock market has gone every way but up – and with it the value of your stock portfolio. What’s an investor to do?

“Stay the course” is still the best advice. But staying the course doesn’t mean sitting on your hands. It means carefully assessing the market and your portfolio, monitoring whether your program still fits your overall goals and risk tolerance, and, if necessary, taking prudent action.

The key is to evaluate your mix of stocks, bonds, and short-term investments. Then, decide whether you’re comfortable with your portfolio’s makeup, based not on an emotional reaction to the market or the recent tragic events, but on a clear-eyed evaluation of your appetite for risk.

Do not try to make economic and financial forecasts. Instead, think about what returns might be reasonable to expect from stocks and bonds. To do that, you’ll have to ignore the extremes of the past decade, and assume that over the long haul the stock market won’t provide consistently big gains or consistently weak performance.

A Market Perspective
From the end of 1994 through 1999, the Standard & Poor’s 500™ Index returned a staggering 251%, or nearly 29% per year. Over this period of time (January 2000 through September 30, 2001), the index has returned -27.6%. From the end of 1994 through September 30, 2001, the S&P 500® Index returned 154.1%, or an annualized return of 14.8%.

Just as the outstanding returns of the late 1990s were destined to “come back to earth,” the poor returns of the past 18 months won’t persist forever. Despite the 18-month downturn, long-term returns remain respectable, as the following chart shows:

Average Annual Total Returns for Selected Indexes
(Periods ended September 30, 2001)
10 Years5 Years3 Years1 Year
S&P 500 Index12.7%10.2%2.0%–26.6%
Wilshire 5000® Index11.9%8.6%1.9%–29.0%
Lehman Brothers® Aggregate
Bond Index
Source: The Vanguard Group, listed index providers.

Common Investor Pitfalls
If you discover that you’ve made some investment mistakes, now may be the time to fix them, even if the repairs are a bit painful. For example, if you’re not diversified enough, you may decide to rebalance your portfolio.

However, you must be careful not to fall into the trap of mistakenly believing that you can correct past errors by abandoning the investments that performed poorly and loading up on those that seem “safer.” By shifting the concentration in your program, you’re simply exposing yourself to different – but still significant – risk. A portfolio composed solely of value stocks or bonds can be just as dangerous as a portfolio of only growth stocks.

Investor Don’ts
Don’t expect performance – good or bad – to repeat. Market leaders eventually lag and market laggards periodically have their day in the sun.
Don’t reach for yield. With interest rates low, higher-yielding investments look tempting. But higher yields always mean more risk.
Don’t make big, sudden changes to your investment plan. It’s okay to make adjustments, but do so gradually.
Don’t give market experts too much credit. Ignore forecasts and keep your long-term goals in focus.
Don’t abandon diversification. Concentrating your assets is a dangerous way to invest.
Another pitfall is viewing the changes in the value of your portfolio as an actual profit or loss. If you’re not planning to tap into your assets soon, a decline isn’t really a “loss.” Likewise, you haven’t struck it rich if you recorded a sizable gain in an investment you’re not going to touch for 20 years.

Finally, don’t forget about costs when evaluating your investment plan. Because stock returns are expected to be lower in the future than they were in the past, and because bond yields are at low levels, costs will become a much bigger factor in determining your ultimate investment success.

Wilshire is a registered trademark of Wilshire Associates Incorporated.

Lehman Brothers is a registered trademark of Lehman Brothers, Inc.

Standard & Poor’s®, S&P®, S&P 500®, Standard & Poor’s 500, and 500 are trademarks of The McGraw-Hill Companies, Inc., and have been licensed for use by The Vanguard Group, Inc. Vanguard mutual funds are not sponsored, endorsed, sold, or promoted by Standard & Poor’s, and Standard & Poor’s makes no representation regarding the advisability of investing in the funds.

© 2002 The Vanguard Group, Inc. All rights reserved.