Just a month or so ago, we used this space to write about simple portfolio building and about how important it is to have a plan for managing your long-term investments, particularly your retirement accounts. Volatility has come roaring back into the market. The volatility rollercoaster usually is accompanied by an emotional rollercoaster, and this is precisely the time it is important to have a plan and to stick with it.
The truth is that the stock market averages one decline of 14% annually, and daily declines of 2% or more happen 5 times per year on average. (Source: Dow Jones) In 2019, when stocks gained more than 30%, we saw two pullbacks of more than 5% during the year. (Source: LPL Research) After a historically calm stretch to end last year and start this year, larger than normal volatility shouldn’t come as a surprise. We didn’t expect stocks to pull back this quickly, but we’re still within the normal range of market volatility. Investment professionals generally define a market correction as a 10% or more loss in the market indices. The correction becomes a bear market when the decline reaches 20%.
Stock market investments are usually only appropriate for long-term investing. Investor sentiment and the herd mentality can move stock prices in the short run. However, take a minute to remember what shares of stock, and the market overall, represent: ownership in real businesses. When a company issues stock, it is selling a percentage of ownership. Today, most publicly traded companies issue millions, or even billions, of shares of stock, so each share represents a very small percentage of ownership. To understand the concept, consider a business with two owners, each holding 50% of the company. Obviously, each owner would have a say in how the company is managed, and they would split the profits between them. Publicly traded stocks work the same way, except the owners number in the thousands, and the percentage owned by each one is tiny. While the value of stock changes second by second, minute by minute and day by day based on what someone else is willing to pay for it, ultimately the value of the stock is the value share of future profits. To invest in stocks, you must be optimistic about the future. You are expecting the company you are investing in to grow its profits over time.
Asset allocation is the share of your investments you have in each broad asset class. The three main classes are stocks, bonds and cash. Within each of these broad classes, there are many sub classes. Asset allocation is part of your overall financial plan, and like all aspects of your plan, should be reviewed periodically. The asset classes will have different returns each year, and over time your portfolio can become out of balance. Part of your review process should be to rebalance back to the correct allocation for each asset class. Your overall asset allocation plan will also change over time as you get older, the time horizon for your goals shortens, and your financial circumstances change. Short-term market conditions may not be a good reason to change your asset allocation plan, however. In fact, adding discipline to your portfolio may be an additional benefit of having an asset allocation plan.
Each time you review your financial plan, either for yourself or with your advisor, it may make sense to ask about your asset allocation, and how much of your portfolio is exposed to stock market risk. Consider whether your investment mix is appropriate for your age and financial circumstances. You may wish to review or ask your advisor your advisor to review if market performance has caused your asset allocation to diverge from your plan. If so, consider bring in back to what your plan suggests.
Drops in the market are not an enjoyable experience. Unfortunately, it is a normal part of investing, and can occur in healthy markets. Emotion is the enemy of investment success, and times like this underscore the need to have an overall financial plan, including a plan of how to invest your assets. A plan may help to keep emotions out of the investment process. Assets committed to the stock market should be longer-term assets – money you won’t need to access for at least a few years. Maintaining a long-term perspective and focusing on the underlying fundamentals of the economy and the market may be a useful approach.
To hear the podcast of the Smart Money Management radio show on this topic, or others, go to our website at alderferbergen.com.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
All investing involves risk including loss of principal. No strategy assures success or protects against loss.
Asset allocation does not ensure a profit of protect against loss.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.
Securities and financial planning offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC