Michael Callahan
The hardest part about investing is being patient despite the day-to-day noise that comes at us from all sides. Turn on the news, and you’ll hear headlines (guesses) about why the market was up or down that day. Go online, and you’ll find all sorts of opinions from very smart people telling you why now is a great time to either buy or sell. The key to investing successfully over the long term is to ignore just about all of it. Yes, even Jim Cramer.
Instead, create a financial plan that outlines your financial goals, and then design your investment strategy in line with that plan. This helps to focus your attention on what matters (reaching your goals), rather than on the short-term swings of an unpredictable market. It will hopefully also reduce your stress level, knowing that there’s no action to take, not take, or regret either way.
While anything can happen in a given year, over time your long-term investment strategy will be the key to your success.
Better Rates of Return
When viewed on a short term basis, the stock market seems random. In fact, since 1916 the Dow Jones Industrial Average has been positive on only 52% of all days. When it’s positive, the average daily return has been .73%, and when it’s negative it’s been -.76%. Almost a coin flip.
During that time, the Dow has only been at new all-time highs 5% of all days. So as an investor we’ve spent 95% of the time feeling like we’ve “lost money,” since most investors anchor to the highest value that their portfolio has reached. Almost doesn’t seem worth it.
But over that time period, the Dow is up 25,568%.
Over the short term, the stock market can seem completely random. Over the long term, though, it’s our most powerful ally in helping our portfolio grow to reach our goals. Growth can happen slowly, but boy is it powerful.
Market Declines Add To Your Rate of Return
Ask any investor what they fear the most, and they’ll tell you that it’s a big drop in the stock market. That’s understandable, since none of us like to see the value of our portfolio fall. In reality, though, market declines add to your rate of return over time.
The key is in having that financial plan in place, and having the proper portfolio for your situation. Make sure that you have a few years’ worth of living expenses in conservative investments so that when the market does fall, you don’t need to sell any of your stock investments to pay the bills.
If you don’t need to sell stocks, then a decline in their value won’t negatively impact your lifestyle. You can afford to wait it out and use it to your advantage by rebalancing your portfolio.
For our clients, we have a specific asset allocation that we believe is right for them. When the stock market declines, the value of the stock portion of the portfolio shrinks, and it throws that allocation out of balance. To correct it, we sell some bonds and buy stocks to get things back to where they should be. When the market does well, we do the opposite and sell stock to buy bonds. That way we know that we’re always buying low and selling high. The ability to buy stock at cheap prices during times of market turmoil adds to your rate of return over time, and actually make it more likely that your financial plan will be successful.
Focus on What Matters
None of us invests simply to see if we can beat the stock market over short periods of time. We invest so that our portfolio can grow and can help us live the life we want to live. Focusing on the former can make it much harder to achieve the latter. Worrying about and reacting to short term moves in the market are a sure-fire way to derail your investment strategy. As financial columnist Andrew Hallam has said, “Your portfolio is like a bar of soap. The more you mess with it, the smaller it will get.”
Instead focus on what matters, which is the probability that you’ll be able to achieve your financial goals. Ups and downs in the market are expected and are built into that probability. So when a year comes along when the market is down 20%-30%, as it is from time to time, that’s not a time to abandon your long term plan. Instead, it’s a great time to reassess your risk tolerance, rebalance your portfolio, and confirm that your plan is still on track.
If your long term financial plan can’t withstand a decline in the stock market, it’s time to change your plan. Our investment team would be happy to discuss any questions regarding your investments or long-term plans. Contact us today!