The Calm Before the Storm
Posted: Farrah Gandhi
In light of a much-anticipated active hurricane season, we’re reminded that now is the time to prepare for the proverbial storm. There are many key facets to being financially prepared including knowing where you stand with regards to insurance, estate planning, taxes, cash management, investments and risk. We can help you prepare. As a continuation of our previous “We Keep Dancing” WJNotes, we discuss what to do to prepare in advance of any market downturn.
First and foremost, it is important to review your objectives and your risk tolerance. Are you taking enough risk? Are you taking too much risk? Can you still achieve your goals by taking less risk? Control what you can control. Much as the saying goes, “all ships rise or fall with the tide”, it’s difficult to control exact return. However, it is possible to manage the level of risk you take in portfolios. In other words, it is possible to mitigate some of the downside when the tide goes out.
Once that level of risk and benchmark is defined, it is our job to manage around that risk level, increasing or reducing risk in portfolios depending on the market environment. Our goal is to reduce the level at which portfolios go down should the tide go out while still participating in the upside.
Secondly, set realistic expectations and stay invested. In the previous WJNotes, we mentioned an article written by Jason Zweig of the Wall Street Journal where he described a recent survey of a group of wealthy individuals that expect their portfolios to earn 8.5% annually after inflation. However, the reality is the average individual investor has only earned 2.3% versus a diversified portfolio (60% stocks/40% bonds) earning 6.9% and the stock market (S&P 500) earning 7.7% annualized. See the graph below by Dalbar, Inc.:
Not only has the average investor earned a low rate of return compared to other investments, the stock market and a diversified portfolio have historically earned less than even investor expectations. The primary reason for poor performance for the average investor is their timing of buy and sells. They tend to buy during strong markets and sell in weak markets. Exactly opposite of what they should do. When you try to time markets, you make a couple of decisions at the same time: 1) Now is the right time to get out; 2) I will know when to get back in. In the long-term, staying invested will pay off. See the chart below which demonstrates how major asset classes and a diversified portfolio have greater predictability in the long-term:
The key to successful investing is to have a plan and stick to it. If you have questions about your portfolio, please contact us.