Danger Will Robinson!
Danger Will Robinson! What a fun childhood memory that show is. And yes, I’m standing here flailing my arms with a warning – Danger! Danger! – about the market, the media and the hyperbole. Feeling good about your portfolio? The DOW is up 9% since the election! Woohoo! The S&P is up 7%. And the bond market is down 3%. We tend to focus on the stock market when things get moving. In fact, based on the call options pricing, Wall Street traders are the most bullish since 1997! (I think I just impressed myself there for a minute.) They’re so excited. But think about it: if we maintained this pace, the market would be an annualized 78%! And that is just not sustainable.
So, the warning isn’t necessarily about what the market has done or will do. Instead, let’s put things in perspective… because the danger is that you may be feeling rather euphoric about the rise in the DOW and S&P, and therefore tempted to make imprudent moves with your money.
Firstly, the pundits did what they do best, they got it wrong…AGAIN! The many doom and gloom prognostications about what the market would do post-election were just silly. Still, they had many people a bit panicked.
Secondly, stock benchmarks just did something in the first week of December that they haven’t done in nearly 20 years: five major U.S. stock-index benchmarks finished at record highs on the same day. It appears that the market really likes what they’re seeing regarding president-elect Trump’s pro-business policies and cabinet lineup. Remember, the market is forward looking and prices are ‘baked in’ based on news and expectations. By the way, Bloomberg had a piece about the stocks ‘you need to own’ a while back. Those stocks are up about 5%, while the market is up 9. Just sayin’…
However, putting those increases into perspective might give you pause. The real return over the last couple of years, with this recent increase included, is roughly 2%. In fact, if the DOW had moved according to its previous actions over the last several decades, we would be looking at a DOW of 24,000!
How’d we get to that number? Well, it’s just math. The long term return – rolling periods of greater than 10 years – of the DOW is 10%; the increase between 2005 and 2015 was 8.5%. In 20 years, if the market earns 7%, the DOW will be at 65,000. If the ROR is 10%, it’ll be 114,368. If it’s 3.5%, it’ll be 33,626.
It’s worth pointing out that 1,000-point moves for the Dow aren’t what they used to be. In other words, when the Dow struggled and finally doubled from 1,000 to 2,000 in 1987 that move represented a 100% advance, but a climb to 20,000 from 19,000 represents a comparatively pedestrian 5% rise.
Remember: the DOW is just 30 companies and is only one measurement of the market. It just happens to be the most well known and most referred to. So it often serves as a ‘benchmark’ for how many people view their overall investments… which is misleading.
Think about this: over the last 5 years (approximately), Wall Street was open for business about 1200 days. If you missed the 15 best days for investing, what do you think your return would be? How about zero…zip…nada. You have to be in it, to win it! Fast forward 20 years – you will either tell your kids you were in the market… or you could have been. And if you got out in the last 5 years or so, and can’t figure out when to get back in, I’ll offer Professor Eugene Fama’s advice – “Buy high and hold!” (And you need to come see me.) In other words, get back on the horse, the train, in the car – choose your metaphor. Because technology is taking off and new companies are made every day.
Here are five of the most important investing actions – keep them by your computer.
- Build a globally diversified, properly allocated portfolio
- Use the factors!
- Reinvest all interest and dividends
- Manage the volatility…or risk
- Rebalance back to targets. We’re selling stocks in some instances right now (i.e., selling high).
We’re doing that!!!
While there are no guarantees with any investment strategy, including annuities by the way, a prudent strategy incorporates those four things and discipline for the long term. It is the only way to achieve a successful, systematic withdrawal plan when income becomes a primary objective.
One final note on recent market actions: the Fed just raised rates by .25%. The WSJ just had an article about long term bonds (10 years+) taking an ugly turn. Blackrock is warning investors who own long term bonds. Why the fuss? Because in a rising interest rate economy, (we’ve been in an interest declining environment since 1982) longer terms suffer serious price drops. Imagine that see-saw from childhood (where did those go anyway?!). Bonds with shorter maturity are closer to the apex so the swing in prices versus interest rates is not as volatile. Sitting out at the ends of the see-saw, the volatility can nearly mimic stocks and is a risk factor you don’t need. We use short and intermediate bonds for this reason.
In conclusion, we live in a world where all crystal balls are cloudy. Investing is about maximizing your risk-return ratio and dealing with uncertainty. Unlike the poker table, where we can calculate the odds of drawing a full house, with investing, we don’t know the odds of another event like 9/11 occurring, or the odds of having another global financial crisis like we experienced in 2008…. or what a presidential election will bring. The best we can do is use the research on what really influences returns and stack the odds in our favor. No matter the horizon, the best odds of success are associated with constructing portfolios diversified across all the factors, not just a single factor with the largest historical premiums like the DOW. It’s essential to control our behaviors by sticking to the plan!