Dear Friends,
Natural disasters such as the recent hurricanes that hit the Gulf coast are devastating to the individuals and areas affected. Thanks to 24-hour television coverage and pictures transmitted via the Internet, the rest of us are saturated with immediate and graphic images of the after-effects.

The personal stories are heart-wrenching, the warnings about higher fuel prices are frightening, the cost to repair the damage sounds overwhelming.

In short, it’s easy — and natural — to become emotional about this kind of event. What you don’t want to do is let your emotions affect your investments.

Ibbotson Associates (search), a well-known provider of information about the financial markets, looked at the total return on the S&P 500 Index — a gauge of the health of the largest companies in America — immediately after four other major natural disasters. Then they calculated the return an investor would have earned 6 months, one year, and three years later.

The events include Hurricane Camille, which, like Katrina, was a Category 5 storm that slammed the Gulf Coast. Hundreds of lives were lost and damage- even when counted in 1969 dollars- ran into the billions.

It’s easy to forget, perhaps because the visuals were not as dramatic, but the drought and heat wave that hit the Midwest and East Coast in the late 1980s was even more deadly: 5,000 deaths are linked to this event. Industry and agricultural losses hit $40 billion.

1992 brought Hurricane Andrew to Southern Florida. 125,000 homes were destroyed. Total price tag: $27 billion.

The fourth example is the massive flooding that swamped the Midwest the following year, causing $21 billion in damages.

In every example, the biggest mistake an investor could have made would have been to bail out of his or her investments when the disaster struck. Although the stock market was under water (no pun intended) a month later in three out of these four disasters, without exception it had more than recovered three years later. In fact, in three cases the gains were above-average. Click here to view this chart (pdf).

Take the most recent example of Hurricane Katrina, which struck New Orleans and vicinity in late August. The next month happened to be September, which is historically the worst month for stocks. According to Ibbotson, when you look at every September from 1926 through 2004, the average return in the stock market has been a loss of 1.1 percent.

This year, the S&P 500 posted a gain of 0.8 percent in September. Not only was this the month after Katrina, it included Hurricane Rita!

The message, says Ibbotson’s Jerry Korabik, is that you “shouldn’t let emotions change your strategy” if you’re investing for a 5-, 10- or 20-year goal such as retirement.

Short-term, disasters can be frightening, costly, and even depressing. And, yes, this might cause some investors to sell, pushing stock prices down. But over the long term, what happens in the financial markets is much more dependent on the economy and corporate profits.

On the other hand, although the Ibbotson data suggests it’s not wise to bail out of stocks after a natural disaster, it could also be a colossal mistake to assume it’s a good time to invest a lot of money in the market just because stock prices have declined. You might be thinking the hurricane caused the sell-off when, in fact, other investors are getting out because they’re concerned about the economy slowing. If they’re right and you (mistakenly) see this as a “buying opportunity,” you could be sorely disappointed.

The other lesson, according to Korabik, is that the safest way to weather a natural disaster (financially speaking) is to be diversified. The S&P 500 consists of 10 industry sectors and, of course, the 500 largest companies in America. While some industries — such insurers — might be hurt by a natural disaster, others — such construction companies and home builders — stand to benefit.

But even within an industry sector, you can’t assume all companies that are going to be affected in the same way. Not all insurance companies had exposure to the Gulf Coast. And within the oil sector, some firms are going to incur significant costs to repair their facilities, while those that specialize in laying pipelines and building infrastructure are going to reap big profits.

Hurricanes Katrina and Rita were just two of many things that affected the stock market in recent weeks. Rising interest rates, skyrocketing oil prices, the war in Iraq, terrorism fears, and, of course, corporate profits, all had an impact on stock prices. Focusing on just one factor — the hurricanes, for instance — would cause you to overlook others that, from a financial standpoint, might have a greater (positive or negative) impact.

Over the long term, Korabik maintains you’re much better off sticking to a diversified investment strategy — whether that’s as a buy-and-hold investor or someone who is investing a certain amount of money at regular intervals, such as monthly. Trying to outsmart the market by guessing when to get in or out is “dangerous,” he says.

Next time a disaster strikes let your emotions prod you to open your checkbook and make a donation to charity. Just don’t let them rule your investments.

Hope this helps,

Gail

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