by Christina Povenmire CFP®, MBA and Barry Jamieson, CFP®, MA
What a difference a few months make! Over the past month it seems like every day comes with considerable market gyrations. Indeed, the VIX index, a key measure of stock market volatility, is up over twice the moving average level of last year, while major asset classes are slightly below their benchmarks from the end of 2017. Many of our clients seem surprised by these gyrations after experiencing the substantial and steady growth of 2017. But the reality is that the 2017 market growth was more the aberration than the norm. The volatility being experienced now is more typical of what happens in the later stages of a mature stock market cycle or, quite frankly, just about any time at any stage!
Market uncertainty can surely lead to more anxiety and negative perceptions of one’s financial health. In our survey of Ohio dentists, 43% indicated their retirement assets were somewhat or much lower than expected. Dentists need a disciplined investment approach in order to stay calm through market turbulence. To maximize returns at a reasonable level of risk, it is important to stay focused on one’s goals rather than on short-term market performance.
Forget About Market Timing!
Trying to beat the market will be a time consuming and self-defeating process, so don’t do it! No matter what the market timing strategy, it will ultimately fail. Academic research supports this fact. A white paper published by Dimensional Fund Advisors showed that if an investor who was fully invested in the S&P stocks since 1990 and had subsequently withdrawn their funds over the best-performance day during the period 1990-2017 for just one day, it would have affected annualized returns by -0.43%. Let’s pretend this investor had started off in 1990 with $100,000 in funds invested in an S&P index fund and had subsequently withdrawn and reinvested their position in stocks during the best market-return day for the index for the period 1990-2017. Not keeping invested in the market would have cost this hypothetical investor $125K for their simple mistake!
The Benefits of Diversification
Similar to the mistake of timing the market is the mentality that picking a “few good winners” is going to enhance returns in your portfolio. It is true that the returns of a few high growth stocks (assuming you can actually predict the winners) can beat the returns associated with a diversified portfolio; however, diversification limits the overall highs and the lows of a portfolio compared to the concentrated portfolio, which lowers risks. And giving up a bit in return is substantially outweighed by the benefit of lower risks. Just looking at returns without looking at risk is a recipe for frustration and ultimately failure. The successful investor will buy groups of mutual funds, or asset classes that are not well correlated to each other. An example of two uncorrelated classes are bonds and real estate. Typically, in a high-inflation environment, bonds do poorly, because in times of high inflation, interest rates rise, and bond prices go down. Real estate, on the other hand, fares well in periods of high inflation, so one would expect that bonds and real estate are somewhat uncorrelated to each other. Having a number of asset classes represented in your portfolio (e.g. Domestic and International Bonds, International Developed and Emerging Markets, Domestic Small Cap and Large Cap, and Real Estate) will help manage the implied risk level of your portfolio without compromising too much on returns. Virtually all investors, dentists included, worry about market returns. And while financial planning can’t control market returns, it can control our exposure to market risk, by ensuring that the portfolio is properly diversified across asset classes.
“What, Me Worried?, Nah!”
History has shown that market downturns occur regularly. According to American Funds, since 1900, the Dow Jones Industrial Average has declined by 10% or more about once a year. Market downturn affects not only your investment accounts, but also your patients’ accounts, resulting in fewer dentist visits when the chips are already down. A comprehensive financial plan takes these inevitabilities into account, factoring in best- and worst-case market scenarios so that you stay on track for meeting your long-term goals regardless of market conditions. Perhaps more importantly, your financial planner attempts to optimize your returns when balanced against your tolerance for risk. For example, as you grow older and near your retirement date, your financial plan helps you decrease your exposure to higher-risk investments, such as stocks, and increases your exposure to lower-risk investments, such as bonds or cash. This type of risk management is a major component of financial planning.
While financial planning can’t control market returns, it can control for market risk and ensure that your portfolio is on track to meet your goals. A comprehensive financial plan takes into account the inevitable ups and downs of the market, factoring in best- and worst-case market scenarios. Ultimately financial planning is about peace of mind. So when the market is exhibiting (seemingly) unusual volatility, be sure to stick to your financial plan! By managing risk and return investors can have confidence that their financial plan is well positioned to meet their goals no matter what the market is doing.