Navigating the Turbulent Waters of Investing
/By Shelley Murasko
“The true investor welcomes volatility ... a wildly fluctuating market means that irrationally low prices will periodically be attached to solid businesses.”
– Warren Buffett
Last summer, I decided to take my preteen kids on an ocean boat excursion. As the children of a father who suffers horrible seasickness on the water, they had never experienced deep sea boating. So on a beautiful morning in late July, we boarded the Catalina Express in Dana Point Harbor and set off for Catalina Island’s gem of a town, Avalon.
With family genetics in mind, I considered the possibility of nausea. Since the trip was only 90 minutes long, I figured we could overcome the turbulence by sitting on the outside deck and focusing on the horizon. Thinking back, I should have devised a better plan.
Although the large Catalina Express boats usually offer a smooth ride, every wave felt like a roller coaster. Within minutes, my daughter was nauseous, and my son was turning green. The sea’s turbulence made it impossible to enjoy the beauty of the day. In fact, friends who had planned to visit Catalina that same day canceled their trip due to the high waves.
Throughout the journey, I kept reminding the kids to stay calm and keep their eyes on the horizon. After all, once we were Catalina bound, our choices were limited. Jumping overboard was the least desirable option, so staying the course as calmly as possible was really all we could do.
As the seconds ticked by like hours, I hugged my kids tightly, continually searching the skyline for the craggy, emerald island of Catalina.
When we finally arrived, the day became quite joyful. We swam at Catalina Beach, hiked the hills, and took a Jeep® tour of the island that included a buffalo sighting. As evening approached and we prepared to head back to the mainland, we were sad the day was over.
To avoid the discomfort of our previous boat ride, I vowed to be better prepared for the journey home. Before boarding the boat, I picked up some Dramamine® to head off any bouts of seasickness. As a result, my kids were much happier on the return trip. It helped that the evening waters were significantly calmer. Despite our rocky start, the trip was a success and a positive experience we will never forget.
The “Seasickness” of Stock Markets
Managing seasickness is similar to managing volatility during rough stock markets — like the one we’re facing now. The month of January got off to a very turbulent start, continuing into February. At the worst point, the U.S. stock index, the S&P 500, had dipped 12% while the NASDAQ had plummeted by 20%.
During times like these, I often wish I could send some metaphorical Dramamine in the mail with brokerage account statements. It would help clients shake off their lower statement balances more easily. Instead, I’ll share a few pointers for you to keep in mind as we endure this rocky ride.
Human Nature Abhors Loss
First, it helps to acknowledge that we humans are wired to feel distress when we see statements decline in value. Research has shown that investors often react more strongly to investment losses than gains.
In fact, a landmark study in 1995 found that investors felt 2.5 times worse about a $1 loss than the good feelings they experienced about a $1 gain. 1
Volatility Is Part of the Investing Experience
Just like choppy waters are a common occurrence during an ocean boating experience, volatility is inherent in investing. Since there’s risk when investing in businesses, there’s also an eventual return. After all, if this investing stuff was easy, the return would be very low. It’s by taking on stock market risk that we eventually get to experience the reward of capital gains.
Consider this example: From 1984 to 2018, the S&P 500 Index experienced a median intra-year decline of -9.9%.2 In other words, at least once a year, stocks dove about 10%. Yet they still posted positive returns in 29 of those 35 years with a median annualized total return of 13% and an average annualized return of 11%.2
Bear markets are always scary, but only devastating if you sell amid them. There have been 12 bear markets since 1901. The average duration was 22 months with an average decline of 42%.3 Navigating through turbulent waters can be unnerving, too. And yet the only way to get to your destination is to keep on cruising.
Turbulent Waters Won’t Tip Over a Balanced Boat
In case of an emergency or rough seas, it helps to keep a ship balanced. This counters the waves and reduces rocking. That’s why large cruise ships usually house several ballast tanks well under the waterline. These serve as a center of gravity to help maintain steadiness in bumpy seas.
If your portfolio features a reasonable asset allocation—somewhere in the range of a 60% to 40% stock/bond split—market corrections will only affect a portion of your overall nest egg. In addition, sensible retirement portfolios have a ballast just like the big cruise ships, which includes investment-grade bonds of various terms and varieties.
Additional balancing strategies are used for stock-heavy portfolios with much longer time horizons. They commonly include international and REIT funds in the structure to incorporate holdings that correlate differently to the U.S. stock market.
Remember, This Too Shall Pass
Each generation has faced its share of challenges. While experiencing today’s choppy waters, it’s easy to become overwhelmed by the severity of the moment. History has dealt serious blows before, from the Global Depression to cold and hot wars to presidential assassinations and pandemics.
When viewed through the lens of history, we know that even the worst turbulence has not stopped the inevitable climb of the stock market. Why is this? Humans are remarkably resilient. In our free market system, the human potential for solving problems will eventually rise to the occasion once again.
Your Future Self Is Counting on You to Stay the Course
Most financial plans—whether saving for college, retirement, or a house—are based on achieving a rate of return that can only be realized by staying the course through stock market waves. Your plan is no different.
Take a page from storied investor Warren Buffett. When asked by CNBC in 2009 how it felt to have lost 40% of his lifetime accumulation of capital, he said it felt about the same as it had the previous three times. The bottom line is that market corrections do not equal a financial loss unless you sell.
What Can You Do Now?
Now that we’ve seen a dip, here are a few sensible steps you can take to ride out the turbulence.
· Keep a positive view of corrections. If you have high-quality investments, don’t be tempted to tinker with your portfolio. Experience shows that a correction’s “bark” is worse than its “bite.” Long-term investors can view a correction as an opportunity to add new money to proven investment positions at favorable prices.
· Be less interested in your statements. Checking them once a quarter is more than enough for long-term investors. I am often amazed by the number of people who tell me they check their accounts daily. This is one more way the internet does investors a disservice.
· Resort to stock market history. Refresh your memory on other near-death investment moments that turned out okay. Two interesting reads in this category are Stress Test (Geithner, 2015) and Boom and Bust: Financial Cycles and Human Prosperity (Pollock, 2010). Check them out to expand your learning.
· Stay true to your allocation. Though it takes discipline and a degree of courage, check your percentage of stocks relative to bonds. If it’s under target, reallocate more to your stock funds.
· Invest more. Once you have high-interest debts like credit cards paid off and an emergency fund established, add money to your investments consistently over time. You may even want to take advantage of market dips to maximize results.
· Control what you can. There are many actions you can take, including a review of your spending priorities, tax planning such as adding to IRAs, or Roth IRA conversions at lower asset values. Another wise move might involve harvesting tax losses in taxable accounts.
Once a portfolio incorporates stocks to attain long-term growth, abandoning them in a during a correction is the worst option. The sea will eventually calm down. Though the ocean might offer calmer waves sooner than the stock market, it’s best to carry on as competently and as calmly as you can. Throughout the investing journey, sensible investors keep emotions in check and their eyes on the horizon.
Do you have questions or concerns? Call us, we are here to help.
Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Investing involves risks.
Wealthrise Financial Planning is an investment advisor registered with FINRA. This material is provided for informational and educational purposes only. It should not be considered investment advice or an offer to buy or sell securities.
Sources:
1. Hammond, Chris. (2015.) Southeastern University. "Behavioral finance: Its history and its future." Based on a 1995 study by Benartzi and Thaler.
2. Invesco. (Oct. 17, 2019.) Compelling Wealth Management Conversations 2018. Retrieved from https://www.invesco.com/us-rest/contentdetail.
3. JP Morgan. (Dec. 31, 2019.) JP Morgan Asset Management “Guide to the Markets,” p. 14. Retrieved from https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/.
