The Grinch Fails Again!
The Grinch Fails Again!
Stock market volatility has reared its ugly head like the Grinch sneaking into Whoville to steal Christmas joy. But just like the Grinch failed to steal Christmas cheer from Whoville, this market correction will fail to derail long-term financial plans. It’s natural to prefer a continuous climb of a raging bull market, reality is, that’s not how markets work. Pullbacks, as uncomfortable as they may feel, are necessary and a healthy reaction when valuations get too high.
Previously, we’ve noted concern about high valuations in the U.S. capital markets and assessed that a correction was necessary to bring asset prices back to reasonable levels. No one can time the markets, but we did feel it was prudent to exercise caution in this environment. We’ve let cash accumulate in order to have “dry powder” available to invest at more attractive valuations should a correction occur. Stock price-to-book valuations had elevated to more than two standard deviations above their mean, which had only occurred two other times (right before the dot-com bubble burst and the Great Depression).
While we can take prudent steps to reduce volatility (risk) in portfolios, we cannot eliminate it altogether. That risk is necessary to achieve the long-term returns and outperform inflation. Periods of volatility rear their ugly heads at times, and it is just a part of investing. The number one risk to our investment objectives is our own psychology. Behavioral finance has proven time and again that the natural “fight or flight” response all humans have, which may save your life in the natural world, is detrimental to your well-being as an investor.
We have seen different reactions to this market pullback from our clients, ranging from “Should I plan to go back to work?” to “I hope the market pulls back further so we can start buying again.” Regardless of where you are on that spectrum, rest assured our long-term portfolio strategy remains in place and it assumes market pullbacks and corrections will happen.
Last week our team gathered in our Folsom office (with our New York state team members on the phone) and Jim Johnson, CFP® stopped in for a visit. For those of you who do not know Jim, he founded Lighthouse Financial Planning many moons ago. He hired Debbie Grose, CFP® who became his successor when he decided to retire. I worked under the Lighthouse Financial Planning (LFP) umbrella as an advisor prior to founding Lake Tahoe Wealth Management, Inc (LTWM). Lake Tahoe Wealth Management merged with Lighthouse Financial Planning on 1/1/2016. Jim has been involved in the financial planning profession through LFP, the Financial Planning Association, pro-bono work, and many other areas of financial planning before many of the financial planners who work in the business today knew what financial planning was. Suffice to say, he is a man of great character with a lot of experience.
I made the comment to Jim, jokingly, that he chose a great time to retire. Jim laughed, looked over at me, and he said (I am paraphrasing here):
“Richard, I went through five bear markets as an advisor. You are likely about to go through your third, and you will probably go through five before you retire. It is just the nature of markets. You guys manage my money, and I am not worried at all.”
Of course, with his experience and knowledge, it is easy for him not to worry. Our team at LTWM is not worried in the least. We know what to do in these environments. We have been through these environments. We have great confidence in a positive long-term outcome (as long as we exercise proven portfolio methodology). Yet, for those who are newer to investing or to working with us, our greatest concern is alleviating their anxiety.
We know that stock markets are volatile, and we include that in our financial planning projections and portfolio construction. According to Yardeni Research, over the past 31 years the S&P 500 has lost 5% or more of its value 24 times. Out of these 24 pullbacks, 3 turned into bear markets where the S&P 500 lost 20% or more of its value. We are in the midst of one of those corrections. The other 20 pullbacks equated to value erosions of 5.8% to 19.9%. On average, a correction occurs about every 16 months. While the market rarely follows “averages”, this statistic demonstrates how common market pullbacks are.
Most market corrections end up being nothing more than short-term events that give investors an opportunity to buy high quality investments at a good price. In our blog posts we have been lamenting about how badly a correction is needed for this exact reason. These corrections, and even bear markets, are temporary in nature and prices have proven to recover over time. In fact, as of March 21, 2018 on a trailing 31-year basis, 2,885 days were spent in some sort of peak-to-trough correction whereas a considerably longer period of 8,438 days were spent in a market rally.
So what should you do when the market gets turbulent? The first thing to do is remain calm. If you are a client of ours, we have already accounted for times like this in your financial plan and portfolio construction. No one can control the markets, so we should focus on what we can control… keep saving if we are in the accumulation phase of life, keep our spending within the outlined levels in our financial plans, and stay invested over the long run. Market pullbacks provide us the opportunity to buy investments at a much more attractive price, and when our rebalancing process is triggered that is exactly what we are trying to do. Time and again the people that maintain portfolio discipline end up in better shape over the long run than those that panic and sell out or try to engage in market timing.
Jim Johnson reminded me about Black Monday, which happened on October 19, 1987. On that day, the Dow Jones Industrial Average dropped a whopping 22.61% IN ONE DAY! Now when you look on a chart (which we included below), that drop is merely a tiny blip over the long run. The dot-com bubble and the Great Recession do not look nearly as frightening as they did as the time period expands. Even with all of our years of experience that we have on our team here at Lake Tahoe Wealth Management, it is always a great opportunity to sit down with a former team member with many decades of experience under his belt and reflect on the past.
With that said, our portfolios are designed to have expected volatility less than the stock market in general, due to the inclusion of bonds and cash. We hope that you will have peace of mind for the rest of the Holiday Season knowing that our team is diligently watching over your life savings and that we had a plan in place for this type of event well before it ever occurred (sound financial planning, appropriate portfolio asset allocation, and rebalancing strategy).
From all of us here at Lake Tahoe Wealth Management, ignore that Grinch and enjoy Happy Holidays and look forward to a prosperous and joyful New Year.