The Practiced Science of Patience in Forecasting
Just as the sun rises in the East and sets in the West, the stock market will advance and decline, but it has always grown following its declines to reach new highs. Common questions we hear from clients include, “When will the market go down again?” and “What should I be doing with my money?”
Predicting what the market will do in the short-term is nearly impossible. But we do recommend that our clients take a strategic approach to the market. That approach includes identifying financial goals, building a plan to reach them with investments that fit those goals, and then reviewing the process on an ongoing basis.
On average, we will see three 5% and one 10% (or more) declines each year, a 15% (or more) decline once every 2 years, and a 20% (or more) decline every 3½ years.
Peter Lynch, Fidelity Magellan manager of the 1970’s and 1980’s said about market corrections, “when they’re gonna start, no one knows. If you’re not ready for that, you shouldn’t be in the stock market. I mean the stomach is the key organ here. It’s not the brain. Do you have the stomach for these kinds of declines?”
There are a few ways to prepare for these merciless gastric attacks. One way is to anticipate and mentally brace for the onslaught. Unfortunately, there will probably be several false starts before it actually occurs, so you get to experience failure in advance. A few false starts leave you mentally spent when it actually occurs, and you find yourself in the throes of a painful decline. Emotionally you just want the pain to go away, and the only way to end it is to get out of the stock market completely, swearing never to invest there again.
However if you follow The Trust Company’s philosophy and prepare in advance by doing long-term planning that incorporates your future needs, investment time horizon, asset allocation, and investment selection, you’ll be in a far better position to succeed. Our objective is to understand your goals and position your portfolio to meet your needs. The biggest fear we hear about investing in stocks is the fear of running out of money because the stock market is down. If you have income needs, we will reserve that plus a safety cushion in fixed income to fund them for the next five years. Generally speaking, any monies allocated to stocks should have a minimum five year time horizon. This way, should a decline occur, this will allow time for equities to recover.
We believe that market timing is very difficult to execute. Looking at Table 1, with its precise durations and frequencies, you might think it would be easy to execute a market timing strategy. However looks are deceiving because you have to be right twice: first about when to get out of the market and second, the much more difficult decision, when to get back in. If fear drove you from the market, it is likely that the market will be much higher before you get back in. As Table 2 shows, the average equity and fixed income fund investor who moved in and out of the market fared much worse than those who simply invested in buy-and-hold indexes like the S&P 500 and Barclay’s Aggregate. Emotions caused them to get into and out of the market at exactly the wrong times.
Our perspective is one of diversification. Ben Carson, of A Wealth of Common Sense, articulates it well saying, “Investing really comes down to regret minimization. Some investors will regret missing out on huge gains while others will regret participating in huge losses. Pick your poison. Which regret will wear worse on your psyche? Missing out on future gains or future losses? In the absence of being able to predict the future, diversification is your best option to balance these two regrets.”
Quarter to Date Returns as of 9/30/2014:
S&P 500 1.13%; Russell 2000 -7.36%; MSCI EAFE -5.88%; MSCI ACWI (global stocks) -2.30%; Barclays U.S. Aggregate Bond 0.17%