With the recent extremes and an investor’s natural bias to loss aversion, our U.S. stock markets have become downright wonky. A financial adviser lays out a plan of action to keep it all in check.
WASHINGTON — If you are like many investors, you may be wondering what happened to the stock market. Our calm, steady ascent was abruptly displaced by roller coaster monthly returns.
The S&P 500 Index was down 6.8 percent in October, up 2 percent in November and back down 9 percent in December of 2018. The S&P 500 return of -4.4 percent for 2018 was a sharp contrast for investors after earning 22 percent for 2017 and double-digit returns in seven of the past ten years from Jan. 1, 2009 to Dec. 31, 2018.
Perhaps even more unnerving was the increased frequency of huge one-day point swings, especially if you followed the Dow Jones industrial average where 1,000 points represent a 5 percent movement and dominated the news.
With the recent extremes and an investor’s natural bias to loss aversion, our U.S. stock markets have become downright wonky — you know, off-kilter.
So, let’s take a deep yoga breath and put this wonky stock market in perspective now and for the future by having a plan of action to keep your emotions in check and faith in your long-term goals.
Know what you can and can’t control
At any given moment, there will always be plenty of positive and negative economic, political and company-specific news influencing the direction of the stock market.
Extreme market volatility, up and down, is exacerbated by computerized trading models which automatically buy and sell securities based on preset inputs for large institutions and index funds in nanoseconds. When markets turn south, trading models are programmed to sell and when they move north, they are programmed to buy.
Macro events, computerized trading and market returns are simply out of your direct control. However, as an investor, you do have control over your personal savings and spending, your short- and-long-term goals, as well as how you diversify your investment portfolio in different asset classes.
Review your goals and risk tolerance and invest accordingly
Periods of downside volatility are a particularly important time to review your overall financial plan and goals with your adviser. It’s natural to have fears and concerns about not achieving your real-life goals, so take the time to examine your savings and investment risk in conjunction with your specific goals and timeline to achieve them.
The first step is to make sure you have sufficient cash reserves to cover your household living expenses (preferably for at least one year) plus any defined short-term goals such as your kids’ college tuition or house down payment.
The next step is to review your portfolio’s current asset allocation and determine if it needs to be rebalanced according to your investment objectives, risk tolerance and timeline. Remember your asset allocation is your primary driver of risk and return. When you rebalance between asset classes, you sell a portion of an asset class, like stock funds that have grown faster (sell high), and reinvest in an asset class, like bond funds, at a lower price (buy low). Rebalancing typically occurs annually, when certain asset classes have outgrown your intended allocation target, or if you change your goals.
A well-diversified portfolio of stocks, bonds, real assets and alternatives is designed to help minimize drawdowns during periods of market upheaval and generate different sources of return based on the risk-and-return profile of each asset class relative to various market conditions. The overall goal is to generate consistent, long-term performance in line with your personal risk tolerance and goals, not a specific equity benchmark.
Stay focused on the long term and stay invested
Trying to successfully time each market move is practically impossible. Over the past 20 years, from 1998 through 2017, the S&P 500 produced an annualized return of 7.2 percent, assuming you remained fully invested. During this same 20-year span, investors endured two major market downturns (including the -37 percent return in 2008), multiple geopolitical conflicts and natural disasters. Missing out on just a handful of the best days in the market is surprisingly costly. Six of the best 10-day returns occurred within two weeks of the worst 10 days. Had you missed the 10 best days, your annualized return would be cut in half to 3.5 percent; even worse, had you missed the best 40 days, your annualized return would have been -2.8 percent. Based on history, long-term investors should stay invested during the bad times, as well as the good times, so they don’t miss the rebounds.
Having a historical perspective helps to accept volatility as a normal part of investing
As much as investors want to avoid market declines, they are an inevitable part of investing and happen with regularity.
At some point, “Winter is Coming,” as they say on “Game of Thrones,” and we are going to slide into a Bear Market which is part of the normal investment cycle. The last bear market in the U.S. occurred between 2007 and 2009 during The Financial Crisis and lasted roughly 17 months. Here’s what you need to know about the average bear and bull markets which is nicely illustrated by First Trust using S&P 500 performance from 1926 to 2018:
The average bear market lasts 1.4 years with an average cumulative loss of -41 percent.
The average bull market lasts 9.1 years with an average cumulative total return of 473 percent.
Almost every year has its rough patches but keep reminding yourself that the S&P 500 has achieved positive annual returns in 29 of the last 39 years.
What does all of this really mean? Investors need to ride out volatile periods and not react emotionally by selling out of fear. They should stress-test their financial plans on a regular basis to account for changes in net worth, income and lifestyle to make appropriate adjustments, and understand and accept certain levels of risk in order to achieve their long-term financial goals.
Financial success doesn’t happen overnight. This is why discipline, rebalancing and keeping things in perspective are so important.