PLANNING FOR MARKET VOLATILITY AS PART OF YOUR INVESTING JOURNEY
Although we may not be able to plan for escaped crocodiles on planes, we can certainly plan for market fluctuations.
December 9, 2022
Most of us don’t have a plan for what to do when a crocodile emerges from a duffel bag while on a small airplane, and the events of August 25, 2010, prove this to be true.
A small L-410 Turbojet had begun its descent when it became known to everyone on board that a crocodile had been smuggled on board. Frenzy ensued as the reptile escaped in the small confines of the plane. While passengers scrambled about, the flight attendant chose to run to the cockpit to hide. Unfortunately, that decision led to their demise. The 18 passengers all followed suit, causing the plane to become imbalanced and crash into a house 1.2 miles from the runway. There was one survivor.
Amid all the turmoil we’re facing today, I’m sorry for another depressing story, but I think this has more to teach us about human behavior and investing than we think.
On a recent weekly market commentary call, Senior Investment Consultant, Dave Humphreys, talked about how flight attendants are the people on flights we look to for confirmation on whether we’re safe or if we should be concerned. If they’re calm and carrying on their normal duties, we tend to relax and enjoy our flight. If we see them talking amongst each other with concern on their face, or buckling themselves in, or worse yet, sprinting to the cockpit, our fight or flight impulses spring into action. Danger must be present, and danger demands a response.
Isn’t the same true for investors watching the reactions of financial experts? Based on all the sensationalized headlines, it sure feels like many in the world of finance are running to the cockpit, inevitably influencing investor behavior in a negative way. The temptation today is strong to stop contributing to investments or even move to cash, because after all, we’ve been in a downward slide in both the stock and bond market since last December and some people have reached their breaking point. Both decisions are rooted in protecting ourselves from perceived risk. However, both decisions counterintuitively open us up to more risks. Let’s not run from the crocodile only to find ourselves in a plane crash.
Unfortunately, we’re working against some pretty strong behavioral biases that can hijack even the most logical investor, unless of course you have a plan before the storm hits. And while it is completely unrealistic for us to have a plan for escaped crocodiles on planes, it is paramount we have a plan for bear markets and recessions, because they will happen multiple times over the course of our lives. Without a plan, “the stock market [becomes] a device for transferring money from the impatient to the patient,” as the sage Warren Buffet quipped.
Well, the crocodile has already escaped. The S&P 500 is hovering around bear market territory. Now what? We’d like to leave you with three thoughts.
- If your investments aren’t tied to a plan, now is the time to consider changing that. Ideally, investors should have enough in cash or cash equivalents to cover needs in the next 12-24 months that income doesn’t cover. Knowing you don’t need the money in your investments today, allows you to be patient and withstand volatility. Having a plan will also help you understand what rate of return you need for achieving goals and help you set an appropriate risk tolerance for your investments that you can stick with. After all, we know the stock market is resilient. 87% of 5-year S&P 500 returns are positive dating back to 1926 and 100% of 15-year S&P 500 returns are positive over the same period. If you have time on your side, focus on the long term. The only way temporary losses become permanent is by veering off course and trying to time the market.
- Speaking of market timing, a bear market is not the time to move investments to cash, so long as you don’t need the money today. We understand how unsettling it can feel when, for example, 25% of your portfolio has dissipated in less than 12 months. For many that is six figures worth of hard-earned wealth and it feels like there’s nowhere to hide with bonds also being down. One response could be to say, “I’ve had enough and I’m going to sit in cash until things stabilize.” Our concern is that in order for this strategy to be successful, you have to time the market twice. It has to go down from the point of exit, and you have to get back in before it reaches the point you got out. Again, the only way to make temporary losses permanent is through market timing.
We don’t have to go back far to see how difficult it is to get market timing right.
Let’s go back to the last bear market which was March of 2020. The S&P 500 was off the previous market high by 25% on March 12th, and let’s imagine that was your breaking point. You decided to move all your investments to cash. The bottom was reached on 3/23, 11 days later. April 3rd was the last day where the S&P 500 was below your selling point on March 12th. You had 22 days to profit off your decision. But perhaps when the market returned to the point at which you got out, you were assured it would fall back in time. After all, we were still in a pandemic lock down and the news wasn’t exactly good then either. Unfortunately, as of the date I’m writing this (November 16, 2022), the S&P 500 is up 60% since then. Even with this current bear market we are in, as bad as it feels, we haven’t even returned close to the point at which we exited the market in this hypothetical scenario. With how readily available information is today, markets often move faster than we can react.
- Lean into the market downturn. Time is what it will take for your current losses to rebound, but the current moment presents a great opportunity to buy stocks at a discount. We’ve seen 25% or greater pullbacks only 9 times since 1950, the last of which was 2020. Although it doesn’t always feel good contributing money when the markets are falling, 2020 showed us that as of 11/16/2022, new contributions made after the pre-COVID high returned 17% for contributions made at the top and around 77% for contributions made at the bottom. Over a 30-month span with another bear market thrown in, those are good returns. Compounded over the years to come, history suggests they’ll be even better returns. On 8/12/2020, the S&P 500 returned to the pre-COVID high, meaning investors who sat on the sidelines to infuse new cash until then have earned 8% or less cumulatively on new contributions. With hindsight, bear markets are a good time to deploy excess cash that’s not needed in the short term or to consider increasing your equity exposure if your risk tolerance allows. Time and the power of compounding will do the rest.
With a good plan, investors hopefully won’t be phased by sensationalized headlines or what their portfolio does in the short term. Volatility is a part of the investing journey and to be expected. Bear markets happen every 6.5 years and recessions happen at the end of economic cycles – both should be built into your plan. Showing a plan works, regardless of volatility, reminds us that chasing a finite boost to our portfolio through market timing isn’t worth the risk of jeopardizing our goals. Not sure if your financial plan is built to weather these storms? Connect with the Voyage team to learn more about how we could help.
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