Steeling Your Mind for Market Volatility

Lately we have been hearing quite regularly from our clients, “My account value is dropping. Why is the value declining so fast, and is there anything we can do about it?” Very valid and important concerns.  These questions reminded me of my favorite finance professor in college who used to state repeatedly; “in any investment, any investment (he would emphasize) returns are commensurate with the amount of risk you take.  And if there is one thing you learn in this class, make sure you remember that fact.” Over time, I have understood that he was not diminishing the rest of his class material, but he was stressing the importance of that truth. 

Let us look at two very different behaving investments to illustrate the tradeoff between risk and return.  Short Term US Government Bonds, essentially risk free, experienced zero down years over the past 90 years. The result of owning short term bonds was an inflation beating annualized return of 3.44%.  On the other hand, investors in the stock market over the same period were rewarded with a lofty 10% annual return. The price for that higher return came with some very wild swings in the market, and 24 years of negative returns.  Stated differently, annual positive returns only happened 73% of the time rather than the 100% with safe short-term government bonds. 

The graph above demonstrates how these investment options performed. Since higher risk generates better long-term returns, $1 invested in 1926 in the stock market would have grown to $7,347. But, those safe bonds that went up every year, would have grown to only $21!  Basically a difference of over 34,000%.  Imagine leaving one great grandchild your stock investments and the other your bonds.  (DFA Information S&P 500 Return value change from 1926 to 2016.  Similar timeline; one-month US Treasury Bills and US Consumer Price Index.)

By the way, if you are thinking that you don’t have great grandchildren and/or don’t plan on leaving them a portfolio of stocks and bonds etc.., that is fine.  Over the past 38 years, the stock market has had similar risk and return results. Positive returns 29 out of 38 years or 76% of the time, and an average return of 9%.

Unfortunately, for investors, volatility is a necessary part of the experience in growing your wealth similar to turbulence when we travel by air. There is a common myth that a pilot receives advanced notice before their plane experiences turbulence. The reality is that they actually do not.https://www.usatoday.com/story/travel/flights/2014/07/10/5-myths-about-air-turbulence/12301043/  However, most of us continue to fly because we have a destination in mind and a timeline to arrive. Therefore, airplanes play an important role in 21st century travel, just as the stock market has for retirement planning.  Sudden drops in altitude, caused by turbulence, can be frightening and unnerving just like how an investor’s stock portfolio behaved over the 4th quarter of 2018.  We understand and empathize with your experience, and we have gone to great lengths to prepare an investment strategy that will fit your long-term objectives.

Unfortunately, assuming any advisor will see the imminent, but temporary, market turbulence is not a realistic expectation.  There are just too many macroeconomic and market factors to consider. As my favorite finance teacher would implore us to remember, returns are commensurate with the risk an investor is willing to take.  When investors act on their fear, they tend to make bad and damaging decisions.  They lose sight of their long-term objectives for the perceived short-term safety. In some cases, they fall victim to someone claiming to have figured out how to “time” the market. The reality is, if it sounds too good to be true, it probably is, and the price you pay to find out could devastate your life savings. (Recall the myriad of Ponzi Schemes and fraudsters over time.) If you have questions about your portfolio returns during this volatile period, call your advisor.  Even if your performance report is not favorable, our goal is to be Your Financial Partner for Life, which in this situation means walking you through the results and reaffirming that your investment strategy matches your long-term goals.

Bob Lagonegro, CFP®

Financial Advisor