How to Navigate Volatile Markets

By January 4, 2019The Friday Brief

Since October, large swings in the stock market have become commonplace, driven by a ceaseless stream of extraordinary economic and political news events. Apple hardly ever downgrades their earnings guidance. The Chinese economy hardly ever declines. Britain may be forced to leave the European Union without a trade/border deal adding significant economic, diplomatic, and political uncertainty to the region. The US dominance in space hasn’t been challenged since 1969, but China, Iran and others are now saber rattling in this new arena. The Federal Reserve hasn’t raised interest rates four times in a year since 2006. Along those lines, good news is not bad in that as jobs increase and wages rise, investors fear the Fed may keep raising rates to stem inflation fears. The government has shut down for the third time this year. Congress is now officially divided and politicians are more outlandish in their comments than anytime in modern memory.

Markets are digesting more news with greater frequency and impact than ever before. Indexes swinging 2-4% in a day and stocks like Apple, the world’s first trillion dollar company falling 10% in a day understandably concern investors. Stock indexes are down 16% – 20% from their peaks in early October, as measured by the Dow Jones and Nasdaq indexes, respectively. The 7-10 year Treasury, we use to steady our client’s portfolios from volatility is up almost 6% during the same period, despite three Fed rate increases and the potential for more.

It’s helpful I think, to remind ourselves not to impose the large swings we hear of on the nightly news onto our actual portfolio behavior. Carefully constructed portfolios are designed to absorb the wild swings in markets, to mute them, so one’s total invested wealth is not shaken so violently. Large swings in wealth reduce emotional confidence (and health) and similarly, significant wealth volatility reduces long-term planning confidence. So it is important to keep volatility to a minimum.

The chart below helps keep things more in perspective. While the total US market is down 16.3%, the Beacon 60 is down only 7.5% and the Beacon 45, only 4.4%, yet their long-term returns have averaged 8.8% and 7.4%, respectively. It is important to note that these returns are index returns, not actual portfolio returns. Actual portfolios have fees which reduce returns by roughly 1% and cash flows in and out that may increase or reduce returns. Also, past performance is not a guarantee future results.

Another way of reducing portfolio volatility is to run from it entirely when one feels uncertain about the future. But this is a poor strategy for long-term investors for a number of reasons. Gains are taxed when securities are sold in taxable accounts, and transaction costs in all accounts, reduce wealth. Moreover, you have to be right twice about your timing of when to get out and when to get back in, to maintain your place relative to those who stay in. The odds and human nature are stacked against you.

Just moments ago, Fed Chairman Powell announced that the Federal Reserve will be patient amid conflicting economic signals about raising interest rates going forward. The Dow Jones rose from up 200 points to up 600 points in moments. If you got out yesterday for instance, you now have a deficit of 2.4% to make up, and more to cover any taxes and transaction costs you paid.

The extent to which individual investors time the market is huge and hugely ineffective as continually demonstrated by Dalbar. They update their 30-year study every year of stock and bond mutual fund investor results as compared to actual index results. Their latest comment on the report says it all: “No matter what the state of the mutual fund industry, boom or bust: Investment results are more dependent on investor behavior than on fund performance. Mutual fund investors who hold on to their investments are more successful than those who try to time the market” according to Dalbar. The S&P 500 index averaged 10.16% for the last 30 years ended 12/31/2017, while the average investor in equity mutual funds, averaged 3.98%. Emotions can inflict significant damage on wealth accumulation.

The media and technology offer no help. News, commentary, and stock prices are available any time on your PC, tablet, phone, watch, television, or car. The deluge of information is all but inescapable, so we have to create our own set of filters and barriers to levels that don’t overwhelm our resolve and discipline to stay the course. The best way I know to stay your course amidst all the noise and confusion is first to have both a plan and a process that you strongly believe in. And then, in the words of Dr. Maxwell Maltz, through “rational and conscious thought to examine and analyze incoming messages, to accept those that are true and reject those that are untrue.” Test your concerns mentally for veracity, and then against the framework of your plan and process to identify real threats and opportunities. This approach is objective and constructive, the alternative is wasteful worry and worse.

These are the times we believe our planning and process stand apart. Investors tend to be comfortable when markets are steady and rising, but markets turn volatile, we want to be confident that our plan and process can weather any storm. Please give us a call if you are at all concerned.

Author Sam Bass Jr.

Sam founded Beacon Wealthcare in 1998. He has thirty five years' experience investing money for his clients. In 2006 he changed the focus of his firm from asset/return to a client/goal-centered and adopted state-of-the-art planning and management systems to deliver the best fully integrated planning service available. Sam holds a BA in English Literature from Hampden-Sydney College, 1975 and an MBA from Wake Forest University, 1981. He concentrated in International Finance, and did research for an International Finance textbook which included a summer at the London School of Economics. He is married to Sharon, a talented pleinAir oil painter, They enjoy being with their three children, their spouses, and five beautiful grandchildren as often as they can. Sam loves Jesus, sailing, cycling, and writing.

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