Market Volatility: What to Do
“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than in the corrections themselves.” – Peter Lynch
Current market environment
There is a lot about our current market that can feel scary. There are major concerns currently in China, we have experienced falling energy and commodity prices and to make matters more complicated, our domestic markets although volatile as of late, have been on a bull and since March of 2009 and our bond market appears to be ending a 30-year bull run. The argument can be made right now that there is no place to hide. That being said, if investors never invested when the headlines were bad, they would have missed quite an extraordinary run over the last 30 years that showcased an average rate of return for the S&P of 11.06 percent (1984-2014).
Investor behavior
As Peter Lynch’s quote above indicates, our fear often leads us to do the wrong thing at the wrong time. The reality is that as individual prices of stocks fall, there are bargains and opportunities available that present real opportunities.
The irony of investing is that many investors tend to look at previous market corrections as opportunities and current or future market corrections as threats. When, the only difference between these two is time and perspective. Here are a few statistics we are discussing with our clients to keep things in perspective.
Since World War II, there have been 53 up years for the S&P 500 and 13 down years for the S&P 500. The S&P 500 has been up in a little more than 80 percent of the years. Since World War II if you bet against the market, you had a 20 percent or less chance of winning. That isn’t to say that history will continue in exactly that fashion, but it is an important data point to consider.
The S&P 500 for the last 30 years ending in 2014 had an 11.06 percent rate of return while the average equity investor did a 3.79 percent rate of return1. A lot can be said about fees and taxes, but the biggest threat to the individual investor is their own behavior.
The average bond fund investor over the last 30 years actually did even worse than the average equity fund investor in relation to the percentage of return they captured in the bond market. The Barclays Aggregate Bond Index had a return of 7.36 percent over the last 30 years while the average bond investor did a 0.72 percent return which only matched a fraction of inflation.
These data points can be overly simplistic. We do not think that simply comparing returns to the Barclays Aggregate Bond Index or the S&P 500 as the only measure. We believe great portfolios include international investing as well as Mid Cap, Small Cap and a small allocation to commodities and real estate; but that being said, over time these additional asset classes can have a long term risk adjusted enhancement on performance. Looking at the S&P versus the average investor’s return is not the whole story, but makes pretty compelling the negative implications of bad investor behavior.
What to do
Stay disciplined: If you constructed a diversified, well-balanced portfolio that matches your goals and time frames, keep the faith.
Consider rebalancing: This market downturn has probably put most portfolios a little out of whack. Rebalancing gives us the opportunity to buy low and sell high in a disciplined, non-emotional manner.
Put cash to work: You never know ahead of time whether now is the perfect time to invest or not, but traditionally a lower stock market provides the opportunity for a long-term investor to profit. I mentioned the fact that the market has been up 80 percent of the time over the last 66 years and putting cash to work in the volatile times can work very well.
What to do if the market correction goes even deeper (20 percent or more)
Tax loss harvest: This is an idea that most professional advisors will be using well before a 20 percent downturn but for the average individual investor, though it may not be scalable to always be making moves in portfolios. Our advice is to review your accounts to see if it makes sense to lock in losses, but doing so in a way where all asset classes still have coverage. For instance, you can sell one International Fund and lock in a capital loss and buy into another International Fund and still have market exposure to International. There are some wash-sale rules to understand and it is important to understand that these funds cannot be substantially identical but with the advice of your CPA and/or financial advisor, you can make sure the wash-sale rules are avoided.
Consider a ROTH conversion: Market downturns do two things for ROTH conversions. They make the taxable income that would need to be generated by a ROTH conversion less since the account value is lower, and they also typically create an environment where there is more upside available in the tax-free environment because typically the lower stocks drop, the more upside stocks have in the future. A well-timed conversion during the crash of 2008 had significantly lower tax liability for the conversion and an explosion of appreciation in a tax-free environment once the markets return to their previous highs. (We are not predicting an environment like 2008. We are just using this as an example).
Hug your kids, take your wife out on a date, pet your dog and turn off the TV ... watching the market and worrying about the future never improves your chances of performance.
1Jay Moreland. “A Review of Dalbar’s 2015 ‘Quantitative
Analysis of Investment Behavior.’ ” “http://www.theemotionalinvestor.com” www.theemotionalinvestor.com, 11 May 2015.
Article prepared by Wealth Management Advisor Ben Beshear with the cooperation of Northwestern Mutual. Beshear is an insurance agent of Northwestern Mutual based in Cincinnati. Email Todd at HYPERLINK “mailto:ben.beshear@nm.com” ben.beshear@nm.com. Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company (NM), Milwaukee, Wisconsin, and its subsidiaries. Joseph B Beshear is a Representative of Northwestern Mutual Wealth Management Company® (NMWMC), Milwaukee, WI (fiduciary and fee-based financial planning services), a subsidiary of NM and federal savings bank.
Past performance is no guarantee of future performance. All investments carry some level of risk including the potential loss of principal invested. No investment strategy can guarantee a profit or protect against loss.