This week we’ve heard a lot about the U.S. stock market achieving new highs. So what? Should this record transcendence inspire confidence or fear, action or inaction?
You’ll find sufficient supporters for both the pessimistic and the optimistic view, with a far greater number of pleas to act on these views. But I invite you to consider the relative irrelevance of market highs for the following simple reason:
Any investment with a positive expected rate of return should regularly revisit and recreate its all-time high as a matter of course. Otherwise, it wouldn’t have a positive expected rate of return!
The caveat is that the higher the expected rate of return on a particular investment, the more irregular we should expect its flirtation with market highs to be. Perhaps that’s why the broad index of large U.S. companies—the S&P 500—has experienced 121 all-time highs in the past 16 years while the Nasdaq—an index of tech stocks—has experienced only nine.
You have three choices in the face of the mania that Wall Street and its many mouthpieces both conjure up and rely upon: you can agonize, act or exercise apathy.
I realize how hard it is not to agonize—to not fall prey to the hundreds of daily invitations seeking your attention. But provoking agony is an old sales trick designed to get you to act. Many in the financial services industry still get compensated to transact—to sell—not to advise. They make money regardless of your benefit or lack thereof, as long as you act.
My recommendation, therefore, is to exercise deliberate indifference. Receive the information you likely have no choice but to encounter and make an active decision to be passively indifferent.
You’ll likely benefit a great deal more from pursuing a timeless personal memory this week than concerning yourself with a financial benchmark’s all-time high.
Of course, you aren’t really free to exercise apathy unless you’ve acted on creating a well-thought-out investment plan. For starters, here’s a simple DIY portfolio that has beaten the pros.
The movement of markets is so incredibly complicated that even the world’s most skilled portfolio managers struggle mightily to “beat the market” over the long-term. Building a strong portfolio, therefore, must be similarly (and singularly) complex, right? Wrong. While portfolio architecture and management is not easy, here is a seven-step process that makes it surprisingly simple:
Step 1: Know thyself.
This ancient Greek wisdom is where we must begin, because personal finance is more personal than it is finance. Investing is complex because we are complex. Therefore, we must understand ourselves before we try to understand the markets. This means honestly gauging your time horizon and the returns necessary to meet your goals, but it’s especially important that you understand your willingness to take risk in the markets. You must take the gut-check test.
Step 2: Understand investing.
Has the market’s recent volatility worried you? Me too. It’s inevitable. Apparently, it’s how we’re wired. But better understanding that wiring can give us a clear decision-making framework to help us know if and when to get out of the market.
The field of behavioral finance has demonstrated that the pain we derive from market losses impacts us twice as much as the pleasure we feel from market gains. For this reason, investors are well served to name and address these emotions instead of setting them aside as they (unfortunately) have been taught.
We’ve all heard of the cost/benefit decision-making model, but “cost” and “benefit” are intellectual constructs too distant from the actual emotions that drive our decision-making. We need to address the gut—the “pain” and the “pleasure” associated with a tough decision. The following four-step model seeks to merge the head and the gut. And while it’s applicable in virtually any either/or scenario, let’s specifically address the decision to stay invested in the market or to move to cash:
1) The pain of staying invested is that I could lose even more.
Unless you made a resolution not to read, listen to or watch the news in 2016, you’ve likely noticed that “the market” is off to a stumbling start. Indeed, one glance at the headlines, at least the ones that don’t involve the presidential election, quickly reveals that the market is having one of its worst starts to any new year. This is a dubious distinction, to be sure.
The factors involved appear similar to those credited for causing the extreme volatility we saw in the fall of 2015—slower growth in China, falling oil prices, geopolitical instability and the threat of bankruptcies in junk bonds. But the optimist’s case seems equally compelling—high-quality bonds (the only kind I recommend) are performing very well, falling oil prices are good for consumers, the Fed’s interest rate rise signals a strengthening U.S. economy and the most recent jobs report was positive.
An objective view of the market reminds us that on every trading day in history, there have been compelling cases to be made for both optimism and pessimism—for purchases or sales. (Remember that every single security transaction involves a buyer and a seller, each of whom believes he or she is getting the better end of the deal.)
Ultimately, there is only one sufficient answer to the question,
Is recent stock market volatility bugging you?
Do you wince with every headline announcing Greece’s demise, China’s bubble(s), the Federal Reserve’s indecision or the Dow’s down day?
Do you sneak a peak at your portfolio’s performance more than quarterly (or perhaps even annually)?
Does market volatility tempt you to question your investment strategy, even if it’s well thought out and carefully implemented?
Does it weaken your resolve to resist the sky-is-falling siren song heard so frequently in the financial media, or the sales pitch du jour?
Having the right investment strategy is important—really important—and surely contributes to long-term success in building wealth. But no matter how superlative your strategy, it’s your willingness to stick with it that ultimately will help you meet your financial goals.
“Greece is a tiny player in global capital markets. Its default is 100% certain,” says Larry Swedroe, Director of Research for The BAM ALLIANCE and the author of 14 books on investing, including his most recent, The Incredible Shrinking Alpha, co-authored with Andrew Berkin.
“The only question is how much and what they default on,” Swedroe continues. “But with a GNP that is similar to Rhode Island’s, Greece’s default should have little to no impact on the world’s economy, at least not directly.”
So why is everyone so worried?
Because raging forest fires are kindled from a single, tiny spark. “Greece’s default could trigger a broader contagion, like a run on Portuguese banks or a lack of confidence in the ECU, that may have wider ranging implications for larger economies,” says Swedroe, my colleague.
Last year was a tough one for disciplined investors. Disciplined investors know that diversification is a key element of successful portfolio management. But investors who stayed the course and remained diversified were punished for it in 2014, at least in the short term.
Disciplined investors will continue to be taunted over the coming weeks and months by headlines touting the success of “the market” in 2014. “Which market is that?” many of them will ask.
Well, “the market” we hear about most often is the Dow Jones Industrial Average, which represents only 30 of the largest U.S. companies trading on the New York Stock Exchange. A slightly broader barometer of “the market” is the S&P 500 index, a benchmark tracking 500 of the largest U.S. stocks. In this case, “the market” could more accurately be translated as “the U.S. large-cap stock market.”
As if PIMCO needed any more bad press, The Wall Street Journal reported this week that the Securities and Exchange Commission is investigating whether the bond giant “artificially boosted the returns of a popular fund aimed at small investors.” While we should all be attentive to the results of this probe—because I’d bet my lunch money that its implications will be felt beyond just PIMCO—there is an even deeper issue to consider. And this issue has a more direct impact on our individual portfolios and money management choices. The real danger in overstating returns, and indeed the root of most financial missteps, is self-deception.
“How’s your portfolio?”
Who among us wants to feel like a failure? We’ll generally avoid experiencing this sensation at all costs. So, absent conspicuous success, we permit ourselves to believe that we’ve at least not failed, frequently through self-deception.
There is no shortage of receptacles clamoring for your money each day. No matter how much money you have or make, it could never keep up with all the seemingly urgent invitations to part with it.
Separating true financial priorities from flash impulses is an increasing challenge, even when you’re trying to do the right thing with your moola — like saving for the future, insuring against catastrophic risks and otherwise improving your financial standing. And while every individual and household is in some way unique, the following list of financial priorities for your next available dollar is a reliable guide for most.
Once you’ve spent the money necessary to cover your fixed and variable living expenses (and yes, I realize that’s no easy task for many) consider spending your additional dollars in this order: