Navigating todays markets

A new environment may require new tactics

f youre confounded by what the markets do on a daily basis, dont beat yourself up youre in good company.
Many investors, including highly experienced professionals, missed the bottom for stocks in 2009 and got
in later (or never got out in the first place) only to encounter unparalleled volatility remember the 2010
flash crash and the 2011 downgrade of the U.S. credit rating? Some investors got out completely in 2008 and,
despite a major rally by stocks, have never gotten back into the market. Others have sought protection in bonds
and income-oriented investments only to see many supposedly safe holdings drop sharply when interest rates
spiked earlier this year. Truth is, very few investors got everything right over the past four years.

As featured in

WORTHWHILE, a quarterly periodical dedicated to serving the clients of Raymond James advisors and affiliated advisory firms.

At the same time, the need to invest

for your retirement, your childrens
education, your legacy goals and other
personal objectives hasnt gone
away. In fact, investing intelligently
having a plan, knowing what you
own and why is more critical than
ever. After all, you cant expect to
achieve your goals by sitting on the
sidelines. With that in mind, lets look
at where things stand now, what may
lie ahead, and how investors can best
position themselves to achieve their
individual financial objectives. As we
do so, remember that these are general
observations any specific investment
decisions should be made in consultation with your financial advisor and
should reflect your individual situation and personal objectives.

are providing very little in the way

of income, especially when inflation
is factored in. Another is that bonds
and other yield-oriented investments
are vulnerable to declining prices if
and when interest rates move higher.
That doesnt mean cash alternative
investments and bonds dont have a
place in your portfolio. They do. But
it does mean you need to review the
potential effects of rising interest
rates in deciding how to structure your
income-producing holdings.

Adapt to current conditions

Long-term bond investors have

benefited from a historic bull market
that began in the 1980s when Paul
Volcker, then chairman of the Federal
Reserve, raised interest rates to
unheard of levels in order to crush
inflation, which had reached 13.5% in
1981. Since then, rates have declined,
providing enduring support for bond
prices, which move inversely to rates.
To appreciate the magnitude of that
support, consider that the key federal
funds rate, which Volcker had boosted
to 20% in 1981, is now pegged by the

Its been said that investors must adapt

to a New Normal, although theres
no unanimity on exactly what that
looks like. Still, the current environment does have some unusual features
that investors need to consider. For
openers, interest rates remain very
low by historical standards. This has
a number of implications. A big one
is that cash alternative investments
such as money markets, CDs, shortterm Treasuries and savings accounts

Investing intelligently
is more critical
than ever

Fed at between 0% and 0.25%.

Since the Fed cant take rates below
zero, many bond investors are now
focused on when and by how much
rates might rise. Since rising rates
generally mean falling bond prices,
this guessing game has created significant volatility in the fixed income
markets and led some investors to
Be prepared to adjust your course
if you veer from the plan

liquidate their bonds and bond funds.

While volatility and rising rates do
pose risks, its important to remember
that different bonds respond in different ways to higher rates and that
there are ways to reduce the risks
to your fixed income portfolio. One
approach is to focus on bonds with
lower durations since they usually
react less to an increase in rates.

Still many reasons to own bonds

Its also important to bear in mind that
there are many reasons to own bonds,
among them the reliable income they
provide and the fact that they typically
have offset the volatility associated
with stocks. Investors who own bonds
that will mature in a few years may
not be too concerned with interim
price movements since they anticipate redeeming those bonds at full
par value and re-investing the funds.
Investors who own municipal bonds
and/or municipal bonds funds may be
more interested in federally tax-free
income than the market value of their
holdings on their monthly statements.
Also, rising interest rates mean potential opportunities to realize higher
returns on fixed income investments
you may make in the future. Like most
things, rising rates have a good news/
bad news quality.
That said, rising rates will have
varying effects on different types of
fixed income holdings, which brings
us back to knowing what you own. Its
not enough, for example, to know that
you own a bond mutual fund you
need to understand what the fund
itself owns. You dont want to engage
in individual security analysis in a
managed fund, but you do want to

be aware of the overall risk profile of

your bond investments. This goes for
municipal bond funds as well, because
the credit quality of states, municipalities and government agencies that
issue bonds can change over time.
Your advisor can help you with this.
So, with cash yielding next to
nothing and both stocks and bonds
making their owners nervous, what
should investors do?

investors who simply stayed invested

between 2007 and 2013 almost certainly did better than those who tried
to time a very volatile market. While
its difficult in an ultra-connected age
where information pours over us like a
waterfall, your investment decisions
should be based on your long-term
goals, not whats happening in the

markets this week or next.

One way potentially to deal with
volatility, particularly if youre younger
and have a longer time horizon, is
dollar-cost averaging. Investing a set
amount every month or quarter may
actually turn volatility to your advantage by enabling you to acquire more
shares when prices are lower. Doing
this takes discipline, because youll
be putting money into the market
when the headlines and probably
your friends and colleagues are full
of doom and gloom. However, both
academic research and common sense
tell us that one way to acquire assets at
attractive prices is when other investors are selling. Dollar-cost averaging is
designed to help do that for you. Note
that if youre contributing money to a
company 401(k) plan, perhaps biweekly

Follow a long-term strategy

Part of the answer, although it may
seem counterintuitive, is to pay less
attention to the markets and more
to yourself and your financial goals.
If were honest, we know that its our
emotional reactions to what the markets are doing that often cause us
the most trouble. For example, stock

Keep your destination in sight

Stock market snapshot

A look at the S&P 500 from 1981 to 2013
1993
Internet gains
in popularity

1600
1400

7/29/81
Millions watch
royal wedding

1200
1000

6/81
Federal funds rate
raised to 20% under
Chairman Paul Volcker

800
600

10/19/87
Black Monday,
market drops 21%
1/91
First Gulf War

6/18/83
Sally Ride becomes
first American
woman in space

1/20/81
Ronald Reagan
becomes president

8/87
Alan Greenspan
becomes Fed chairman

1/20/89
George H.W. Bush
becomes president

12/86
Iran Contra affair

400

1/20/93
Bill Clinton
becomes president

7/92
Fed cuts discount
rate to 3%

200

12/8/93
North American
Free Trade
Agreement signed

0
1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

Sources: Raymond James research, Standard & Poors, FactSet as of July 31, 2013 | Analysis assumes reinvestment of income but does not include
transaction costs, which would reduce an investors return. The S&P 500 is an index of 500 widely held securities and cannot be invested in directly.
Past performance may not be indicative of future results.

1997

1996

A key part of paying attention to

yourself also means understanding
what your tolerance for movements
in the market (risk) really is. Knowing
your risk tolerance your long-term
tolerance, not how you feel when the
market is soaring or skidding can
provide important perspective for creating an individual asset allocation
model that can see you through the

or monthly, youre already practicing

dollar-cost averaging. While dollar-cost
averaging can be useful in a long-term
plan, its important to note that it does
not assure a profit and does not protect against loss. Because it involves
continuous investment regardless of
fluctuating price levels, its important
to think about your financial ability to
continue purchases through periods of
low price levels.
Having a clear idea of why youre in
the market and what you want your
investments to do for you makes it
much easier to be disciplined. Its
important, therefore, to revisit and
reaffirm your personal goals and time
horizon. Youre investing in order
to achieve certain objectives the
decisions you make should rest on
that foundation.

markets inevitable ups and downs.

Your asset allocation model the
mix of stocks, bonds and cash designed
to achieve your financial goals isnt
something you set and forget. You
need to monitor it regularly to be sure
its reflecting changes in market conditions, as well as in your personal
life. You also need to stress test your
model periodically to assess the likelihood that it will achieve the objectives

Remember, your financial

advisor is there to help

youve set forth. If things are on track,

fine. If theyre not, you may have to
make some adjustments either to
your goals or the model itself.
Remember too that an asset allocation strategy wont work without
rebalancing. All models get out of
sync over time simply because the
prices of the underlying securities
change if stock prices rise, stocks
will automatically account for a larger
percentage of your overall holdings. If,
for example, your model is 60% stocks,

2007 to 2009
Subprime mortgage crisis
Financial crisis
Great Recession

March 2000-2002
Dot-com crash

3/2009
Market bottoms

2/1/06
Ben Bernanke
becomes Fed
chairman

Summer 2009
Official end of recession
Late 2009
Eurozone debt crisis starts

7/02
Sarbanes-Oxley
Act passed

10/97
Economic crisis
in Asia, global
mini crash

1/1/13
American Taxpayer
Relief Act enacted
1/20/01
George W. Bush
becomes president

12/99
Markets climb, Y2K
fears come and go

1997

1998

2012
Fiscal cliff
looms

1999

3/11/11
Japan disasters and
nuclear meltdown
3/03
U.S. and coalition
enter war with Iraq

9/11/01
9/11 attacks

2000

2001

12/16/08
Fed funds rate
lowered to
all-time low

12/26/04
Indian Ocean
natural disasters

8/5/11
U.S. credit downgraded

10/29/12
Hurricane Sandy

8/29/05
Hurricane Katrina

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Understanding bond duration and par value

Fixed income investors are aware
that when interest rates rise, the
prices of bonds and other rate-sensitive securities generally will decline.
In thinking about the potential
effect of rising rates on your bonds,
its helpful to understand the concept of duration, both for individual

bonds might be affected in different

bonds and your portfolio as a whole.

Duration is an estimate of how
much the price of a bond will change
as interest rates change. This is usually expressed in percentages, i.e.,
the price of a bond with a duration
of 2 would be expected to decline
by about 2% for each 1% increase
in interest rates and vice versa. The
higher the duration, the higher its
price sensitivity to a rate change.
In other words, in a time of rising
interest rates, lower duration is generally better for price protection.

may vary, the par value is generally

Duration: An estimate
of how much the price
of a bond will change in
response to a change in
interest rates

interest rate environments. Your

advisor can tell you more.
Another bond term you often hear
is par value, which is the amount
of money an investor will receive
when a bond matures or is called.
While the market value of the bond
fixed at time of issuance. Nearly all
bonds have a par value of $1,000.

par value: The amount

of money an investor
will receive when a bond
matures or is called
Bonds also carry whats called a
maturity date, which is the date
the bond issuer is legally obligated
to return the amount it originally
was loaned the par value to the

Dont let your stocks own you

owner of the bond on that date.

As you work your way through this

review, keep in mind that the securities
you own are tools, means to an end.
They work for you dont hesitate to
fire one that isnt doing its job, or add
to positions that are advancing your
financial goals. Dont be sentimental,
and unless there are significant tax
or other considerations, dont let the
difficulty of acknowledging errors and
taking losses keep you from cleaning
house and positioning your portfolio
for the world we live in now.

Treasury inflation-protected securities, or TIPS, are an exception.

TIPS can mature at a value higher
than the original par value because
the principal increases with infla-

Its possible to compute the

overall price sensitivity of your fixed
income portfolio to rising rates.
Whats known as a shock test can
give you an idea of how much your

30% bonds and 10% cash, youll have

to adjust your holdings periodically
annually is probably fine to maintain that mix. Your goal here is
to take your emotions out of your
investment decisions by adhering to
a formula. Rebalancing regularly
and not changing your schedule or
model in response to every move in the

Once you have decided on a personal asset allocation model, its time
to review your individual holdings
stocks, bonds, mutual funds, ETFs,
etc. to determine if theyre still right
for you. Ask yourself why you bought
each security in the first place and if
that reason is still valid. Evaluate your
portfolio as a whole to determine if
you are sufficiently diversified not
just in terms of stocks versus bonds but
also in terms of large- versus small-cap
stocks, long- versus short-term bonds,
and domestic versus overseas holdings.
Consider the current environment,
where volatility is likely to continue
and interest rates are likely to rise
over the next few years. Think about
your overall time horizon, and what
you expect to happen in your personal
life in the near term.

tion and decreases with deflation,

as measured by the Consumer Price
Index. When TIPS mature, you are
paid the adjusted principal or original principal, whichever is greater.

market will automatically help you

pare down holdings whose prices may
have risen too much and potentially
put the proceeds into other investments at favorable levels. Rebalancing
also will help ensure that your investments are working together the way
you expect them to, particularly in
the context of your plan.

Monitor your course as conditions change

You wont always know what lies ahead,

but it never hurts to look

About that world. Most serious

economists believe the U.S. economy
is growing at a solid, if unspectacular, rate. Many key sectors among
them housing, manufacturing, autos
and energy are doing quite well.
Corporate profits are high; inflation
and interest rates are low. Although
you might never guess it from the
headlines, the overall outlook for
American business is pretty bright. At

the same time, stocks have responded

by staging a major advance since early
2009, and theres no question there
are challenges ahead. But heres the
thing: There are always challenges
and opportunities. Their nature may
change from one period to another,
but investing is and always will be
about taking on risk (thoughtfully)
in the belief that doing so can potentially provide rewards.
While no one knows what the markets will do, many believe the keys
to investment success really dont
change all that much. Put away as

The important benefits of cash

Investors should focus on
liquidity, optionality
With money market accounts and
similar vehicles paying almost no
interest, cash is trash, right?
Not so fast. Cash provides two
very important benefits that can
make a significant difference for
investors as they work to achieve
their long-term objectives. The first
is liquidity and the second is what
investment professionals sometimes
call optionality.
Liquidity essentially means that
you have quick and ready access
to the money. But it also means
that when an unexpected expense
arises, you dont have to meet it by
liquidating an asset at what may
be an inopportune moment. Selling
a holding when you dont want to
can generate tax consequences, disrupt your asset allocation model and
cause you to eliminate all or part of
a long-term position that would be
better left intact.

Optionality and opportunity

The second benefit, optionality,
takes its name from the fact that
having cash on hand gives you the
ability to act quickly if and when
an opportunity arises. In todays
fast-moving, volatile markets,
optionality can be a real advantage. Many great investors believe
in always holding some cash to be
able to take advantage of bargains
when they appear.
How much cash should you have?
Theres no one-size-fits-all answer,
but many investment professionals
believe 10% of your overall holdings should be in cash. By the way,
were not talking here about the cash
accounts you use for day-to-day
living expenses thats a different
category. Cash in an investment
account is meant to give you two
things: the ability not to have to
do something when you dont want
to, and the ability to do something
when you do.

much as you can in tax-advantaged

accounts. Think long term and try to
ignore the noise. Get good advice.
Diversify. Have a plan youre comfortable with that reflects your individual
situation, timeline and personal financial goals. Stick to your plan, but stay
on top of how its working and be
ready to make any course corrections
that might be indicated.

Next steps
Banish should have, would have,
could have from your vocabulary
Accept that youre in a challenging
investment environment
Evaluate your tolerance for
volatility honestly
Review your portfolio holdings
with your advisor
Settle on a long-term game plan
and stick with it
Asset allocation and rebalancing do not guarantee a profit nor protect against loss. Past
performance may not be indicative of future
results. Investing involves risks including the
possible loss of capital. Debt securities are
subject to credit risk, and a downgrade in an
issuers credit rating or other adverse news
about an issuer can reduce the market value
of that issuers securities. While interest on
municipal bonds is generally exempt from
federal income tax, it may be subject to the
federal alternative minimum tax, or state or
local taxes. Profits and losses on federally
tax-exempt bonds may be subject to capital gains tax treatment. In addition, certain
municipal bonds (such as Build America Bonds)
are issued without a federal tax exemption,
which subjects the related interest income to
federal income tax.
Investing in smaller, newer companies generally involves greater risks than investing
in larger, more established companies, and
may not be appropriate for every investor.
International investing involves additional
risks such as currency fluctuations, differing
financial accounting standards, and possible
political and economic instability. These risks
are greater in emerging markets.

2013 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC 2013 Raymond James Financial Services, Inc., member FINRA/SIPC
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