For my clients who are approaching retirement, the recent world trade headlines have been pretty unnerving. Every time the U.S. and China exchange threats or the “T” word — tariffs — is in the news, the resulting gyrations on Wall Street produce churning stomachs. Investors watch the value of their portfolios drop and they wonder, “Should I get out of stocks altogether?”
In times of high market volatility, however, the most useful reaction is usually to take a deep breath and remind ourselves of a few basics. First, market volatility, by its very nature, is unpredictable. Today’s headlines are already priced into the market, and tomorrow’s headlines are anybody’s guess. When we decide to make radical changes in our holdings on the basis of things we cannot possibly know, we are being driven by emotion rather than evidence. This is almost always a recipe for poor results.
Second, we need to remember that market downturns are usually temporary, and that being in the market on the very best days can be more helpful to your portfolio over the long haul than being out of the market during a downturn. A recent study by Fidelity, for example, found that being out of the market for just the five best trading days from January 1, 1980, to January 1, 2019 — a period of 39 years — would have resulted in a 34% reduction in the value of the portfolio. Let that sink in: just five days out of 39 years can make that kind of difference in total return.
Third, we need to keep in mind that it is impossible for anyone to anticipate where the best returns will lie during any given period in the future. Take, for example, the world equity markets. Consider this chart of annual returns from every stock market in the world from 1999 to 2018:
Source: Dimensional Fund Advisors LP. Used with permission.
Each differently colored block represents the equity market of an entire nation. Developed markets (U.S., U.K., Japan, Germany, etc.) are on the left, and emerging markets (Vietnam, India, Malaysia, Russia, etc.) are on the right. The countries with the highest returns for a given year are in the top row, and those with the lowest are in the bottom row. Looking at this chart, how successful do you think you would be at picking a winner for any given year? I’ll tell you a secret: I would fail miserably. And so would anyone else. As economic news occurs, as patterns of trade move back and forth, as governments come and go, the business prospects for various countries change in unpredictable ways.
Just as no one can predict which country’s stock market will be the best or worst performer in any given year, no one can predict which sector of the stock market — or bond market, for that matter — will provide the best returns for investors.
In other words, there are many factors in the markets that we cannot control. So, what can we do to protect ourselves? The smart answer is that we can focus on what we can control: diversification, rebalancing, and sticking with a long-term strategy that matches our risk tolerance, goals, and needs.
Diversification allows us to quit trying to decide which sectors to invest in or avoid; instead, we establish a broad pattern of holdings across as many areas as possible, realizing that at any given time, one sector may perform better than another. Rebalancing means that we consider the effects of market gains and losses on our holdings and rebalance the proportions to stay within the parameters of our risk tolerance and strategy. Understanding risk tolerance means that we have a long-term view incorporating our plans for the future. For example, as a client nears retirement, it may be appropriate to adjust equity exposure to a lower percentage of the overall portfolio, recognizing that retirees are more vulnerable to the short-term swings in market volatility that are inevitable in the stock market. But it will also mean that we carefully consider the client’s long-term need for income to maintain a desired lifestyle in retirement and recognize the importance of the right asset mix to deliver the needed level of income.
Jim Parker, Vice President of Dimensional Fund Advisors, recently wrote that in investing, the urge to “do something” may be less appropriate than in many other arenas of life. He discusses the Chinese phrase, “wei wu-wei,” which translates roughly as, “do without doing.” In other words, greater or more frantic activity does not always translate into better results, especially in investing.
When the markets are swinging up and down with the daily headlines, the temptation is strong to “do something.” But the wiser course, most often, is to step back, review your strategy, and remember your fundamentals. Diversification, rebalancing, and a disciplined, evidence-based strategy are your best tools. If you’re approaching retirement and worried about volatile markets, let me help you put these tools to work for you.
Stay Diversified, Stay YOUR Course!