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Downturns In The Market Don’t Have To Equal Downturns In Our Emotions – Finger Financial Five #165

“The only mistake is the one from which you don’t learn” – Henry Ford

This piece is going to center around the history of the US stock market, and the lessons that we can apply from that history. Of course, past returns are not indicative of future results, but we can always use the past as a guide to learn from.

The chart below maps out all of the 10+% downturns in the S&P500 dating back to 1928. The red marks are drawdowns that were more than 20%.

Chart source

Many people get flustered, confused, or intimidated by the fluctuations of the market. We naturally want to stay away from risk. But how risky is it really?

Any story can be painted with any color brush, and the brush used above is very red. 

The market has had some large downswings (See the 83% one from 1930-1932, the 54.5% one in 1937-1938, and the 56.8% one from 2007-2009). 

Yet here we are, floating right around highs. 

Time in the market is what has prevailed. Timing the market has not. Meaning that anyone who went through any one of those periods above was able to recover the losses if they held on for the long-run. This is sometimes easier said than done, but with the right temperament, it is usually the right strategy.

For the time frame shown in the chart, there were 22 times that the S&P500 was down more than 20%. So, it is not unusual to have that level of volatility about once every four years on average. The average expectation is a guide over the long run rather than a standard that can be relied upon in a consistent manner in the short run.

We can go into the ‘what,’ the ‘why,’ and the ‘how’ of all of this. (And those of us in the finance industry love to spend plenty of time on all that). More often than not, though, the biggest variable at play is how we respond to these events. 

The ups and downs are inevitable, so learning how to manage them is key.   

Any downturn has the ability to trigger an emotional response in us. If we aren’t careful, those emotional responses can cause us to make the exact wrong moves at the wrong times, which is often more detrimental than the downturn itself. Many of us have examples of our past that we can point to where we responded emotionally and later realized that our reaction was not well thought out. (This applies outside of finances as well.)

Luckily, there are a handful of things we can do to help smooth out the potentially choppy waters.

  1. The S&P500 is not our only option. People may feel that owning companies through an ETF or a mutual fund is a diversified portfolio. This is certainly better diversification than just 1 company, but many of those companies are similar in size, not globally diversified, and the fund is top-heavy. Meaning a large % of the portfolio is in the largest companies. (According to State Street Global Advisors, 29% of the S&P500 is invested in the top 10 companies). So, the correlations of the entire basket can actually be relatively close, meaning that most of them can go down at the same time. So, this isn’t true diversification. For downside protection, it pays to be diversified outside of just large US companies. Source
  2. We don’t need to be overexposed to stocks. Owning other assets that aren’t linked to the stock market can smooth out the volatility. We don’t need to capitalize on every ounce of upside, especially if it means that our downside potential is greater. Think about it this way: You might get to your destination faster if your teenage son or grandson is driving you somewhere, but you might also have a heart attack along the way. 
  3. Creating a tilt in our portfolios toward the quality companies rather than just owning every company. There are many companies in any given index that may not actually be appropriate investments for particular individuals. We can do a deeper level of analysis on which ones have the best staying power, resiliency, and consistency. Putting an emphasis on those companies can act as an additional buffer.
  4. Keeping a cash cushion, so that there is no need to sell investments when they are going through a rough patch. We generally recommend keeping about 12 months’ worth of living expenses in cash, ready to be liquidated whenever needed. Ideally, that cash earns a decent yield for you. (Current Money Market rates are in the 5% per year range. If you are getting less than that at your bank, give us a call, and we’ll talk to you about your options.)

We don’t know what is around the corner, although many people pretend they do. We don’t know when the next downturn will be, how severe it will be, or how long it will last. What we DO know are the principles that have held true no matter how any of that turns out. So, when that next downturn occurs, remember that diversification, emotional discipline, and a long-term perspective remain as the foundational pillars for investing success. The market will have inevitable ups and downs, but we don’t have to let our emotions and our mental health go on that roller coaster ride along with it.

Thanks to Paul Saunders, one of Riverbend’s financial advisors, for writing this. 

I like how James Clear describes three different kinds of decisions.

Some are hats, some are haircuts, and others are tattoos. Hats you can change quickly. Haircuts you have to live with a bit longer. Tattoos are permanent. If a decision is easily reversible (a hat), make it quickly and change it if needed. If it is a tattoo, think long and hard about it before choosing. 

Elliott used this line of thinking in Chemistry this semester. He had almost 100 on all tests going into the final. The final counted only 15% of his grade. He knew he could get a terrible score on his final and still get an A. So, he focused on his other exams instead. He allocated his time and resources accordingly. 

We had our quarterly “Coffee with Riverbend” call this Tuesday. We talked about the market outlook, interest rates, and how to protect your assets using trusts. CLICK HERE to see the video. Or HERE to listen to the podcast.

News from around the office: Dan Johnson, a lead financial advisor with Riverbend,  got back from a Caribbean cruise this week. 

On the lighter side, Elliott comes home for Spring Break this Friday. It will be good to have him home for a week. 

Let us know if we can help you in any way. Email me at [email protected] or call 843-970-1049.

Hope all is well with you and your family,

Jeremy

Finger Financial Five – 5 points in 5 minutes or less – is intended to provide you with a weekly shot of useful financial information.  My intention is to share principles so that you will have more clarity, more peace, and make better financial decisions. 

Investment advice offered through Stratos Wealth Advisors, LLC, a registered investment advisor. Stratos Wealth Advisors, LLC and Riverbend Wealth Management are separate entities. This content is developed from sources believed to be providing accurate information and provided by Riverbend Wealth Management. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stratos Wealth Partners and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.

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