Nobody minds market volatility when it’s in the upward direction. But this week, we got plenty of the type of volatility that we don’t like so much as investors, the kind that inspires headlines with words like “plunge” and that end with exclamation points.
It presents an opportunity, therefore, to remind ourselves of one of the central tenets of the art and science of investing:
You can’t get outperformance without underperformance.
Indeed, the only reason we have a right to expect a higher rate of return on any given investment is that we’re willing to endure greater risk, and, in all likelihood, higher volatility. But just how much volatility?
Let’s look at some of the scariest market moments of the past 50 years, specifically how far the market—in this case, the S&P 500—dropped over a handful of notable time periods:
Investing is a young person’s game, am I right? I mean, I can understand the argument for ignoring short-term market dives when it’ll be decades before you need to actually touch the money. But what about retirees who need income today? Should retirees and near-retirees be cashing out of stocks on fears that a worldwide pandemic will continue to throttle markets?
First, it’s important to address this question on an emotional level before attempting to respond rationally, because it’s not cold, calculating rationale that leads the charge in times of high market volatility, especially of the downward variety. (Indeed, as my friend Jeff Levine said, “Nobody ever seems to mind volatility when it’s up.”) Furthermore, when we are feeling and responding through the fast-acting, impulsive processor in our brain, thoughtful logic isn’t particularly comforting.
Retirees, in particular, may feel downright scared, and perhaps their fear is justified, because:
They feel disempowered because they’re no longer earning a paycheck and are now reliant entirely on sources of income beyond their control.
They don’t have as much time as an investor in his or her 20s, 30s or 40s to recoup losses.
The math does change for those who are in the distribution phase of their life. Losses can indeed be compounded when you’re taking income out of a portfolio, rather than opportunistically buying through regular contributions.
Therefore, whether you’re a financial advisor counseling someone through turbulent markets or a white-knuckled investor eyeing the eject button, please know this: Every emotion is valid and worthy of acknowledgement. The best financial advisors will take it one step further and explore the emotions in play, even enlisting them in support of the best long-term investment strategy.
Once we’ve addressed this valid concern on an emotional level, it’s time to look at it from a logical perspective, and indeed, for most retirees, it’s important to maintain a healthy allocation to stock exposure in order to ensure that your lifestyle keeps up with inflation. In determining how much risk any investor should take, one’s “time horizon”—the ability to take risk—is a material consideration. A retiree in her late 60s has a shorter time horizon than a new investor in his early 20s, but, however limited, theretiree’s time horizon still isn’t zero.
Retirees need to satisfy income needs today, but they also need to address income needs in the future. Therefore, while it’s a slight oversimplification of a total return portfolio strategy, in times of extreme market volatility, I would invite retirees to view the meaningful portion of conservative fixed income in their portfolio as their income engine in the short-term while their portfolio’s stock exposure is designed to generate income years from now.
(Of course, this presumes that one’s fixed income portfolio is actually conservative, a stabilizing force in your portfolio. Corporate, longer-term, and especially high-yield bonds tend to have equity-like characteristics in down markets; so dare to be boring with your fixed income allocation.)
The optimal percentage of equities in a retirement portfolio will be driven by the retiree’s need to take risk. If you don’t need to take the risk, who am I (or any other financial person with a propensity for stock market cheerleading) to convince you otherwise? Yes, you might need a boost from market returns to outpace inflation. And yes, even if you’d struggle to spend all your money in this lifetime if you kept it in a Mason jar, you might consider investing it for the next generation. But there’s no moral imperative to endure market volatility if you don’t need or want the long-term benefits we expect to receive.
And that’s especially because the most important factor in determining how much equity risk you take in your portfolio is your internal willingness to assume risk. This is the gut-check test, and if you’re at risk of bailing out at the bottom—the worst possible time to sell—you must limit your exposure to stocks. Sticking with a conservative portfolio will earn you more in the long run than fleeing a more aggressive one.
Of course, you can only “stay the course” if you have one. You can only stick with the strategy that exists. Typically, emotions are heightened among those who don’t fully understand or can’t fully articulate their strategy and especially among those who don’t have one.
Too many investors own a collection of securities—or even a collection of someone else’s strategies—that have built up over a lifetime, rather than a well-designed, purposely built, customized portfolio. Those investors should be concerned, and they should use this market hysteria du jour as the catalyst for a substantive portfolio review.
If you’re in the minority, however, who do have an understandable, goals-based strategy—who have considered their ability, willingness and need to take risk—and who have proportionately set their exposure to stocks, then by all means, rest easy and rebalance. Know that however ugly this particular market event gets, it likely will not amount to a blip on the radar when looking at your lifetime of investing. Acting rashly in these situations is more likely to do harm than good.
“As you can see, we’re experiencing rough air at the moment. But as a reminder, we can’t predict rough air,” said the Delta airline pilot ferrying me from St. Louis to Charleston (via Atlanta—always Atlanta), “so please keep your seatbelts on whenever you are seated.”
Thank you, sir, for giving me precisely the hint of inspiration I needed to frame this week’s note of encouragement while in the midst of one of the crazier market stretches we’ve seen in a couple of decades!
DANIEL ROLAND/AFP/Getty Images
Of course, statistically speaking, this bout of stock market extremism is more the norm than the exception. No, it’s not particularly normal to have thousand-point-up or -down days for the Dow Jones Industrial Index. But volatility—market ups and downs—is, indeed, more typical than placid markets.
One of the very few market predictions I (or anybody, for that matter) can responsibly make:
The market is more likely to be volatile than not.
Just for fun, Google the words “market pullback.” There are more than 11 million results–many of them market predictions that are worth even less of your time than it took to Google “market pullback.”
However, despite their worthlessness, market predictions remain as predictable as market opens and closes. (And I predict no end in sight.)
First, there’s a clear profit motive. Apparent urgency leads to activity, and activity is still how most of the financial services industry makes its money.
“Bullish predictions encourage investors to pour fresh money into the markets, helping asset management companies to enjoy rising profits,” the New York Times reported, noting that the Wall Street forecaster’s consensus since 2000 has averaged a 9.5% increase each year. They accidentally got it (almost) right in 2016, but in 2008, the consensus prognostication missed the mark by 49 percentage points (an outcome that makes your local weatherman seem like a harbinger of accuracy)!
Unless you made a resolution not to read, listen to, or watch the news in 2020, you’ve likely noticed that “the market” is going crazy. Indeed, one glance at the headlines quickly reveals that the market is experiencing historic volatility—ups-and-downs, with more of the latter at the moment.
But 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, “Why is the market so volatile?”
The market exhibits volatility because that is its nature.
In my hometown of Baltimore, there’s an oft-heard saying that seems especially applicable when, like now, the seasons are changing: “If you don’t like the weather today, just wait until tomorrow.” For whatever meteorological reason, it’s not uncommon for an absolutely miserable Monday to turn into a gorgeous Tuesday. Temperatures have been known to swing as much as 20 degrees inside of an afternoon.
A scientific view of stock market history, unfortunately, shows us an even greater propensity for unpredictability and volatility.
Even the years that we refer to as the “good” ones, in retrospect, test our mettle. For example, between 1950 and 2014, a span of 65 years, the S&P 500 ended the year with a gain 51 times (or in almost 80% of them). Not bad. But in how many of those up years do you think investors would’ve found themselves in a “losing” position at some point in the year?
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.
Unless you live under a rock (check out this Geico commercial referencing under-rock living if you haven’t seen it), you have picked up the message that volatile markets and bumbling economies have again captured the global consciousness. If you looked at the headlines any of the last several days, you may very well have concluded that the sky is falling and the financial crisis of 2008 is returning. A great article in the Wall Street Journal explained “Why This Crisis Differs From the 2008 Version,” but that still leaves us with the nagging question, “What the #@$% IS going on?” (I’m not promoting profanity, only acknowledging that times like these have a tendency to inspire it.)
Strangely, the majority of the talking heads on television render their contrary opinions on what’s going to happen in the future—tomorrow, next week or next month—spending very little time educating us on what the underlying reasons are for our current crisis. In the spirit of the Freakonomics team, who, in a recent podcast demonstrated “Why we are so bad at predicting the future,” I’ll avoid attempts at prognostication and seek instead to explain what IS and what ISN’T going on in the global economy at present, followed by a couple suggested action steps:
Debt ceiling? S&P downgrade?
The big news of the last few weeks has been debate over the debt ceiling and the seemingly corresponding S&P downgrade of the United States government. The market has been expecting this downgrade, regardless of what happened with the debt ceiling, for quite some time now—it wasn’t a surprise. Besides, S&P’s ineptitude regarding the accuracy of their ratings, most notably demonstrated by their maintenance of top ratings on the junk that helped cause our financial collapse in 2008, has justifiably rendered their guidance nearly impotent. It was suggested that if the debt ceiling was not raised, the U.S. would not be able to pay its bills for the first time in history and that could lead to a financial collapse. Well, the debt ceiling WAS lifted, but the market responded by crashing. How do we explain that? The problem we’re experiencing now has little to do with the debt ceiling, but a lot to do with debt, in general.
So what is happening?
The U.S. certainly has its own debt problems to contend with, but while the U.S. media got narcissistically wrapped up in our own debt ceiling and S&P downgrade, it obscured the more imminent problem—major European countries threatening default. We’ve all heard about the financial troubles of Greece, Ireland and Iceland—each of which required financial assistance to stay afloat—but following those three countries are Italy and Spain. They’re much bigger economies, and their failure may not be sustained by the European Union (EU) and the International Monetary Fund (IMF). And just within the last couple days, one of the stronger European countries’ banks, France, is sending warning signs pointing to another potential crisis there.
Deja vu? (Not really)
In the Great Depression, we basically allowed the natural free-market system to run its course. That resulted in the pain of 25% unemployment and a stock market decline of over 90%. The silver lining, however, was that after the economy recovered from its sickness, we got back on the path towards financial health and prosperity. This time around, the government took unprecedented action to keep us from experiencing Depression-like immediate pain, but many suggest they just deferred the problem and that we’ll be dealing with it for many years into the future.
So the United States and other countries around the world started “printing money” to create growth in their economies, in the hope that increased money supply would pull us out of a recession headed towards depression. But while it can’t (yet) be said that the U.S. is again dipping back into a recession (the dreaded “double dip”), some major European countries are headed quickly in that direction, and that contagion could spread around the world. Again.Governments have already started responded with measures similar to those utilized in the 2008/2009 financial crisis; doing whatever they can to create monetary liquidity they hope will spur growth. This could result in a boost for economies and markets in the coming weeks and months, but it’s certainly no guarantee.
So, what can you do?
You shouldn’t make wholesale buying or selling decisions in your investments based on what a market does in a day or a week, but this current calamity should prompt you to return to your portfolio and take a long, hard look at what you own and why. Whether you are a strict buy-and-hold asset allocator or an active investor, your strategy must recognize and contend with the possibility of times like these. You—and your financial advisor—must be accountable to articulate why you own what you own and how you intend to react depending on further developments in this scary story. I’m not recommending you buy, sell or “stay the course;” I’m recommending you educate yourself and then act accordingly, not out of impulse. There is no bliss in ignorance.