The secret sauce to significantly change your returns forever is not what you think. Here are two foundational tips to investing well.
Honestly, today's news reminds me of being on the debate team in high school. (In fact my first kiss was in a library at debate camp, but we can discuss that at a different time.)
In virtually every debate we would try to prove why the other team’s argument would inevitably lead to natural disaster, nuclear war, and the end of civilization as we know it. Do you ever sense a similar strategy when reading headlines? Death and destruction, sex and scandal - these things sell. Fear sells.
It’s tough to live in a soundbite culture! Media, and financial media specifically, has decided the best way to get our attention is to constantly inform us that the bottom is about to drop out.
But what are we supposed to do with all this negative information?
I was recently driving and listening to a financial planner being interviewed. The stubborn news anchor kept hammering him with the same questions: “Is recession coming? Are we about to enter the next major recession? Could the coming recession be worse than 2008?” The planner finally caved in and spoke of a recession with a few “though we can’t be sure” comments thrown in for good measure.
As I listened, I kept wondering how all the viewers were supposed to respond to the threat of recession. They couldn’t do a thing to impact whether a downturn was coming. They certainly couldn’t change the global economic picture, the debts of various countries, or the mounting student loan crisis in America.
I Have An Important Question
While it may be an interesting mental exercise to theorize about when a recession may come, I think there is a far more important question:
If I actually knew the exact day that the next recession would hit, and I shared it with you, what would you do with that information?
How would you practically respond? Would you run to your computer and begin adjusting all your investments? If so, then that’s a big warning sign that you’re not currently invested the right way!
Let’s be straight about this - No one. Not me, not Janet Yellen, and certainly not Fox Business - has any idea when the next recession will come. But it will come! There is no doubt we will experience volatility in the future!
Can Your Portfolio Be Disaster-Ready?
Let’s spend less time trying to figure out the exact timing of a recession, and more time creating a portfolio that we can trust to take us through the good and the bad times. This goes back to the “If-Then” planning that I refer to so often.
If your portfolio will only work when the market is going up, then you're setting yourself up for a lot of anxiety and heartache the next time that the market (inevitably) drops. Instead build a portfolio with the expectation that the market will experience volatility, that way you can just change the channel next time the media threatens the end of the world.
If you’re not sure how the next bout of volatility will impact your portfolio, a simple evaluation can help you understand some good next steps.
This one comes from a family friend, Bill, who I ran into at a birthday party last week. He was absolutely fed up with the market volatility he'd been experiencing all year and wanted my opinion about selling the equities in his IRA and moving to cash. In his words, "Better to cut my losses now, because who knows how bad this could get?"
Well, I get it. Watching the market drop and seeing the retirement funds you're counting on take a hit is not easy, especially after having lived through the debilitating recession of 2008. I acknowledge that there may be specific times that it makes sense to move to a very conservative position, but please hear this: developing a pattern of selling when the market is low and buying again when it is high can severely damage the long term growth of your portfolio. Every year the Dalbar organization studies historical investor behavior to gauge the impact of our decisions to buy and sell on our long term investment returns. The results are staggering. In their 2015 Quantitative Analysis of Investor Behavior, Dalbar showed that from 1985-2014 the S&P 500 returned right over 11%. Over the same time period, the average investor in equity funds only earned 3.79%. Why did the average investor earn so much less? Primarily because of the losses they experienced selling their equities when their values were going down and buying again when the prices were high!
So how do we respond to market volatility but avoid the losses of selling equities when there value has dropped? Well, this is where the concept of "risk tolerance" becomes very important - accurately judging the amount of risk you're willing to take in your portfolio. My friend Bill had not invested according to his risk tolerance. An analysis of the funds he was invested in showed that the losses he was experiencing were entirely within the normal range for the aggressive equity allocation he had chosen. In other words, those funds were performing normally! Bill had loved the significant growth his portfolio had experienced over the last few years, but he wasn't willing to stick around when they had a correction in the other direction.
We must be careful to invest according to how much risk we are honestly willing to take. Because if we get in a pattern of investing aggressively for growth, but selling and getting out every time the market drops, we can really damage our long term returns. That raises one other important question - how do we discern how much risk we're actually willing to take? The way you have responded to dropping markets in the past is the best place to start. Don't choose the risk tolerance you'd like to have, choose the one you've actually seen yourself act on. Far better to have a more moderate portfolio you can live with in good and bad times than one you will pull out of whenever the market dips.
If you'd like to analyze the aggressiveness of your current portfolio and how that matches up with your risk tolerance, we'd love to help! Click here to get started, we're looking forward to meeting you!