Living the realities of risk and reward.

Asset allocation is important because it helps investors manage the risk and rewards of investing. In general, investments have different levels of risk and the potential return (or reward) for taking that level of risk is a higher return. For example, investing in stocks typically has greater risk than investing in quality bonds or cash. In return for taking a higher level of risk (i.e., tolerating the ups and downs of the stock market) investors have the potential to earn higher returns. Quality bonds have less risk that stocks and offer lower return potential, and cash/cash equivalents has the least risk and the lowest return potential.

During the third quarter of 2024—July through September—the stock market offered a lively ride that demonstrated the concept of risk and reward. Major U.S. stock indices bobbed up and down throughout July before dropping sharply in the first week of August when the July unemployment report lagged expectations. The news caused investors to wonder whether the Fed had waited too long to lower rates, the economy was slowing too quickly, and a recession might be ahead, reported Will Daniel of Fortune via Yahoo!Finance.

The stock market rebounded over the remainder of the month as inflation continued to trend lower and economic data remained robust. Then, during the first week of September, the number of new jobs created in August was lower than predicted and investor confidence stumbled again. Uncertainty led to a sharp—and short-lived—decline in stock prices. From that week on, U.S. stock prices trended higher.

Over the quarter, the dips and dives of the stock market made many investors' stomachs drop, but by the end of the quarter, stock prices overall had moved significantly higher. Josh Schafer and Karen Friar of Yahoo!Finance reported:

"Wall Street indexes recorded monthly wins to close out the last trading day of September. Notably, the S&P 500 notched its best year-to-date performance at September's end since 1997…Over the last three months, the Dow led the major indexes' gains, up 8.2 [percent]. The S&P gained 5.4 [percent], and the Nasdaq added nearly 3 [percent]."

Investors appear to have set aside worries about the U.S. economy and rightfully so, according to Mark Zandi, the chief economist at Moody's Analytics. At the end of September, he wrote:

"I've hesitated to say this at the risk of sounding hyperbolic, but with last week's big GDP revisions, there is no denying it: This is among the best performing economies in my 35+ years as an economist. Economic growth is rip-roaring, with real GDP up 3 [percent] over the past year. Unemployment is low at near 4 [percent], consistent with full employment. Inflation is fast closing in on Fed's 2 [percent] target—grocery prices, rents and gas prices are flat to down over the past more than a year. Households' financial obligations are light, and set to get lighter with the Fed cutting rates. House prices have never been higher, and most homeowners have more equity in their homes than ever. Corporate profits are robust, and the stock market is hitting a record high on a seemingly daily basis. Of course there are blemishes, as lower-income households are struggling financially, there is a severe shortage of affordable homes, and the government is running large budget deficits. And things could change quickly. There are plenty of threats. But in my time as an economist, the economy has rarely looked better."