Written by: Corey Janoff
With the recent turmoil in the stock markets, many investors have seen their portfolios decline by five, ten, even 20% in the last couple of months. Is this the beginning of the end? Will all of our investments be completely worthless by this time next year? Should we sell our stocks now and go to cash before it gets even worse? These are the questions the financial media gets us thinking about in times like these. It can make you feel like you’re reliving the children’s story of Chicken Little, as this might be a foreshadowing of the end of the world.
However, don’t forget how the story of Chicken Little ends (spoiler alert: the world doesn’t end, but in some versions of the fable, the panic leads to the demise of some of the characters).
Investors have been spoiled over the last nine-plus years since most investments have increased in value every year since 2008. We have forgotten that on average, stocks end the year at a lower value than they started the year about 25% of the time (1 out of four years). This is completely normal. With interest rates rising, it should be expected that bond prices will decline as well – the return from bond investments will come from the interest payments, rather than share price appreciation.
In times like these, it is human nature to think your current investment strategy isn’t working and needs to be altered. However, the worst thing you can do is abandon ship and completely change your investment strategy.
It is good to revisit your investment strategy and review why you chose this particular strategy in the first place. I’m sure there is a good reason why your investments are allocated the way they are.You cannot control the returns your investments will deliver. However, you can control the strategy and how you implement it.
The LeBron James Analogy
I like sports, so it is easy for me to find parallels between sports and investing. If you are not a sports fan, you will still probably be able to follow this one. Even if you don’t like basketball, I am going with the assumption that most people reading this blog know of LeBron James. In case you don’t know who he is, see below for a photo. He is arguably the best basketball player on the planet since Michael Jordan and has been for the last decade.
Most people would probably agree that if you have LeBron James on your basketball team, your odds of success are good. You are more likely to win the game if he is playing for your team. However, you know that you won’t win every game. LeBron isn’t going to make every shot he takes. He will have some bad games where he misses a bunch of shots, turns the ball over six times, and his team loses by 30 points.
After those awful games, what is the reaction? Do you think the coach and general manager of the team get together and have this conversation?
Coach: “Man, LeBron played terrible last night.”
General Manager: “Yeah, he really did. I think we should trade him. He’s clearly not good anymore.”
Coach: “I agree. At the very least, we should bench him for tomorrow night’s game and play one of the rookie’s instead. If the rookie plays well tomorrow, then we’ll promote the rookie and get rid of LeBron.”
General Manager: “Smart thinking. Definitely need a change after last night’s performance.”
Of course that conversation doesn’t happen! It was one game! Everyone knows that those games are bound to happen from time to time! LeBron isn’t getting traded, released, or benched for a rookie after one bad game. Even after multiple consecutive bad games he will still be in the starting lineup.
We know that the odds of success are highest if LeBron plays. We accept the possibility of a bad game in return for the chance at success. If LeBron plays, the team will likely win more games than it loses. But the team won’t win all of its games. We understand and accept that.
From month to month, year to year, your investments are no different. You won’t see positive returns every time. You have to accept that there will be some months and years that your investments go down in value. That doesn’t mean they are bad investments!
After one missed shot, the coach isn’t going to pull LeBron out of the game. LeBron will miss a lot of shots every game! The best players in basketball only make about half of the shots they take.
Investments are no different. There will be days and weeks where investments go down in value. Just like LeBron won’t make every shot he takes, your investments won’t go up in value every week.
The more frequently you look at your investments and the financial news, the more you will torment yourself by seeing those negative days/weeks/months.
How Often Do You Check Your Health?
How often do you go to the doctor for a physical? Maybe annually? Less frequently than that for some of you? Some of you haven’t been to the doctor in over five years!
How often do you have lab work done? Blood draws, urine samples, x-rays, MRI’s, CT scans, colonoscopies, prostate exams, mammograms, pap smears? Never for some. For others, maybe once per year, or “as recommended by your primary care physician.”
If you check your investments once per week, but you get your health screened once per year, you are basically implying that your investments are 50 times more important than your health!
But without your health, money doesn’t really matter. You could have all the money in the world, but if you don’t have good health, you’re doomed. You would trade all of your riches in a heartbeat for better health.
So why do you care so much about what your investments did this week, but you don’t care what the exact state of your health is today?
I would like to impose a new rule that we are only allowed to look at our investment accounts on days we go to the doctor. Most of the time, we will be pleased to see that our investments are in good shape.If they aren’t in good shape, we could potentially adjust things, if it makes sense to do so.
Just like if you go to the doctor and learn your cholesterol levels are less than ideal, you might decide to exercise more, eat more vegetables and less bacon. It’s a minor course correction, but you probably aren’t implementing a complete lifestyle overhaul.
With your investments, you probably won’t need a major overhaul either. Minor course corrections are probably sufficient if you have been implementing a prudent strategy already.
Or, after the doctor visit, you simply continue on your way and don’t change anything. You would rather eat bacon and die at 75 than eat kale and live to 90. And if you die at 75, you don’t need your investments to last as long, so it’s a win-win!
Some days you feel crummy. You have a cold, a runny nose. Maybe you have allergies and are sneezing a lot. Maybe you have a stomach ache. A headache. Maybe your back or neck hurts. You’re depressed. Stressed out. Tired.
You’re not going to feel perfect every day or every week. You understand that and accept it. Every day can’t be perfect. Just like your investments. They won’t be great every day either.
Reviewing Your Investment Strategy
If you had a well thought out investment strategy four months ago, I am going out on a limb and assuming it is still a well thought out investment strategy today. Just because the markets have taken a step back in recent weeks/months, doesn’t mean your investment strategy is all of the sudden garbage.
Remember, you can’t control what your investment returns will be in a given time period. All you can control is how much you invest, when you invest it, and how you allocate the money across different investments.
I feel your pain when the stock market goes down and it brings your account value down with it. I am in the same boat as you! I don’t like seeing my investments diminish in value on paper either! But we have to remember what we are investing for and the time horizon of our investments. With long-term money, we have time to ride out the bumps and bruises of the stock market. With money that we potentially need in the near future, we should avoid investments that potentially can go down in value significantly.
Assuming most of you are investing for retirement, if you are young and have a long ways to go until you plan on using your retirement money, you probably have a more aggressive allocation of primarily stocks (or mutual funds and ETF’s that invest in stocks). This is likely an appropriate strategy, because it gives you more growth potential over long periods of time. No guarantees of course, but you accept the possibility of temporary declines for the opportunity of long-term growth. If your account goes up or down in value this year, you’re probably not in a position to retire either way. So you have time on your side to let the portfolio do its thing and hopefully appreciate in value over the next 15-30+ years.
If you are near to retirement, or in retirement, you may have a more balanced investment allocation of stocks and bonds. Maybe 60% stocks and 40% bonds. Hypothetically, let’s say you have $5 million total with $3 million in stocks and $2 million in bonds. The bonds are your short to medium-term money that you can to use in the next 5-10 years if the stocks are struggling. Your stocks are your long-term money that you hope will grow over time. You need the stocks to grow over time so you can maintain your standard of living as inflation drives up cost of living. 25 years from now, cost of living will be double what it is today.
If stocks go up in value in a given year, you can sell some stocks and buy some bonds to get back to your targeted 60/40 allocation. If stocks go down in a given year, you can sell some bonds and buy some stocks at reduced prices to get back to your 60/40 targeted allocation.
If you hold high quality bonds, your bonds probably won’t fluctuate in price a lot. Even if the prices of the bonds go down, the interest they pay out will likely offset that. So you have $2 million of conservative money that has a high probability of holding its value.
Your $3 million of stocks are another story. Those could easily drop to $1.5 million in value. If that happens during retirement, you will be pulling money from the bond portion of your portfolio to live on during those years while you wait for the stocks to rebound and recover. If your stocks rise in value in a given year from $3 million to $3.3 million, you will pull from the stock portion of your portfolio to cover living expenses while you keep the conservative bonds for those rainy days.
The strategy isn’t fool-proof, but it reduces the need to panic when stocks go down. If you are well diversified, it is highly unlikely that your investments will go to zero. In order for that to happen, every company on this planet would have to go out of business.
Even if we go into a global recession, as long as there are still people on the planet, they need to eat and they need to buy things to provide for their families. Therefore, there are still opportunities for investors to realize profits from their investments. It might take a while for those profits to materialize, but the opportunity will be there.
And if there are no longer people on this planet, life as we know it is over, so we don’t need our money anymore.
Keep these thoughts in mind when reviewing your investment strategy. Review why you elected to go with this strategy in the first place. If your goals haven’t changed, odds are you probably don’t need to change your overall strategy. If you don’t have an investment strategy at all, now could be a good time to get one.
And most importantly, have a happy and healthy New Year!
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Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including total loss of principal. Consider your goals, risk tolerance, and time horizon before investing in anything. Consult with a financial advisor before developing and implementing an investment strategy.