Sometimes what you need to succeed in investing is vision. Keeping your perspective is key. Vision includes understanding what’s happened in the past, being mindful of what’s happening now, and considering what could happen over a longer term.
When markets are going up, it’s easy to become complacent.
When markets inevitably correct, it’s also easy to become short-sighted and panic. A good financial planner can help you get through a down market.
To be a visionary investor, you need to understand enough about yourself and about the nature of market cycles so that you don’t make classic mistakes when your emotions kick in.
First of all, let’s take a moment to acknowledge the terrific returns in the stock markets over the past ten years. We’ve actually lived through the longest bull market in history. Large-blend stocks were up 355% from March of 2009 through December 2018.
I’m sure most of you also remember the pain that we lived through just before that long bull market. Stocks (both U.S. and international) dropped about 55% in that gut wrenching period. But having a balanced portfolio of stocks AND bonds helped mitigate that risk.
If you had a mix of 40% stocks and 60% bonds, in general your portfolio recovered in about two years. It took slightly longer if you had 60% stocks and 40% bonds—about three years to recover. If you had only stocks, it took about 4.5 years to get back to square one. Each of these asset allocations came with an associated level of risk.
Diversification works. It helps keep us calm when there is chaos all around us. You may not have the absolute highest returns, but you will have a smoother ride when the turbulence inevitably kicks in.
Markets were very unstable in the fourth quarter of 2018—especially in December. There were virtually 20% drops from the highs in both the S&P 500 and Dow Jones Index. Foreign stocks also plummeted.
If we think back to 2017, we had the opposite scenario. Everything went up. And we warned you that 2017 was the exception, not the rule. Now we are back to a more “normal” investment environment. I know it doesn’t feel normal, and there are plenty of things to worry about, but this is where you need to keep your perspective.
Just because we hit some turbulence in December, don’t think the whole year was that bad. The S&P 500 was down about 4%. International stocks were down between 13% and 14%. Bonds were the heroes. And they were flat for the year. The shorter-term bonds typically held their value better than longer-term bonds. That’s in part because the Federal Reserve raised interest rates four times in 2018.
Remember when I said that large-blend stocks gained 355% since March 2009? That also had an effect on the valuations of stocks. They were getting a little pricey! Not after the correction. If we consider a P/E (price/earnings) ratio of 16 is about average historically, then stocks look pretty cheap at a 14 P/E ratio in January.
With lower valuations in the stock market, it may be a good time to invest cash sitting on the sidelines. Make sure you have adequate emergency reserves in case you change jobs or we have a more extended downturn in the stock market. But many investors have excess cash due to fourth quarter capital gains payouts from mutual funds.
Re-evaluate your investment policy. Do you have the “right” mix of stocks and bonds? Or did your portfolio grow to be a bit too aggressive over the past ten years. Rebalancing may be in order. Or perhaps a change in policy.
There are a couple economic factors that could actually keep this economy growing for a few more years. Oil prices have dropped significantly and that helps keep inflation lower. The Fed may pause in raising interest rates this year. That can also help with stability.
Just because international stocks had a tough year is not a valid reason to avoid holding them in your allocation. While we don’t have a crystal ball, it is possible the U.S. dollar may weaken going forward as global markets recover. That may help to boost international returns due to currency differences. We still think it’s important to be diversified globally.
But at some point we will again have a bear cycle where values drop 20% or more. And remember the next bull cycle will follow the bear. Have patience. Both good and bad markets are built into your retirement projections if you’re working with a financial planner who uses probability analysis (like Monte Carlo). While these projections are at best estimates, they can help give you a better sense if your plan will work in a number of changing market conditions.
Understand that investing involves both the upside and the downside. We’ve been blessed with spectacular performance over the past ten years. Expect some volatility now.
One thing I’ve learned over a lifetime of investing is that you never know what will come next. So stick with a disciplined plan and know that we are here to walk on the path with you.
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