This is my column that was originally published in The News Tribune Sunday Feb. 7.
By Gary Brooks, CFP®
The weight of many financial conversations shifted in January to emphasize phrases like “return to recession” and other unpleasantries about money and financial security. In fact, Google searches for “bear market” and “sell stocks” were higher in January than they’ve been since 2008-09.
In this climate – where many segments of the U.S. stock market recently exceeded the 20 percent decline defined as a bear market – a common question arises: What is a good investment for times like this?
It’s natural to think about but it’s a misguided question.
Most of us are not investing only for a time like “this.” The past six months or next six months aren’t likely all that important. You’re likely investing for a much longer time horizon where the conditions of markets and economies will cycle up and down due to many complex factors.
If you’re tempted to shift your investment approach to reduce your exposure to downward markets, you may be exhibiting a tendency that is more harmful than helpful.
When you give too much weight to current events (known as recency bias), you’re more tempted to deviate from the plan you have in place in order to seek less risk or more return elsewhere. This is classic chasing of performance rather than disciplined investing. If you think that market forces are different this time and decide to shift your investments in response, you’ll be more likely to sell low and buy high while increasing your transaction costs to do so.
So if you have some form of investment strategy and you’re just unsure whether it is right, you should probably stick with it. But if you don’t have a coherent strategy that integrates all your accounts, this is an important time to settle on one so that you don’t feel like you need to respond each time investment markets worry you.
BE BROAD, MORE THAN BOLD
Rather than looking for needles – individual stocks or sectors priced more relatively attractive than the market as a whole – buy the haystack as Vanguard founder John Bogle has been known to say.
It’s far harder and much more time consuming to do the amount of due diligence required to successfully find the needles that are out there. Buying the haystack is the only way to guarantee that you get the needles in it. Sure you’ll also get some hay that is of no use (a drag on your return), but better to have that along with the needle(s) instead of searching for a needle, missing it, and not capturing the market return of the whole haystack.
An appropriately diversified investment strategy includes a few different haystacks. You should go beyond U.S. large-cap growth stocks – which may be a tempting haystack because they have provided the best returns of the past few years. Your U.S. stock haystack should include value stocks and small and mid-sized companies. Add to that an international stock haystack and one or more haystacks which represent various types of bonds and you’ll have the building blocks of a portfolio built to carry you through market volatility.
GET ALLOCATION RIGHT, YOU’LL BE ALRIGHT
It’s the mix of stocks, bonds and cash – your asset allocation – that will help you manage your risk while building your financial security. As part of settling on the right asset allocation for you, you should understand a reasonable range of outcomes that could be expected for the mix you choose. A 60 percent stocks, 40 percent bonds asset allocation will have a different risk/return profile than 40 percent stocks, 60 percent bonds. Especially given stretches like global stocks have had since August 2015, it’s important to understand your personal downside threshold. If you think about the possible range of outcomes – good and bad – before you experience them, and settle on something you can live with, you’ll be more likely to make it through market choppiness without feeling the need to react. You’ll be better equipped to keep your focus on the long term.
Even if you’re retired, given expanding life expectancy, you’re likely still a long-term investor. But you may want to be much more protective of steep drawdowns than someone who still has the ability to recover through more saving.
Wherever you are at in your personal financial journey, the best way to handle market volatility is to have a financial plan in place that helps you understand the impact of market movements on your financial goals. Strangely, while Google searches have ballooned for terms like “bear market” and “sell stocks”, searches for “financial plan” have trended down over the past 10 years.
Those who do have a plan, however, are the ones who handle declining markets much better, feeling less pressure to “do something.”