Markets change humans don’t, but you have a (not so) secret weapon
We are five months and counting into a market trending unfavorably. It’s complicated to accept current market conditions when you look at our historically low unemployment rate. The confusion compounds when you look at equally unfavorable bond performance.
We are in a battle between growing inflation pressure and slowing growth. The smart thing to do is diversify, and then diversify the diversifiers. Many will try to time the market and treat this as a “get in, get out” decision and only compound regrets.
The daily noise is loud with massive swings…up,then down, rinse and repeat. The louder the noise, the harder to find the signals. The world we live in doesn't change that dramatically from day-to-day. Emotions do.
Most people aren’t built for this treacherous, confusing investing environment. And if you aren’t confused, then you don’t understand. Side with those that admit it. There are no experts, just cycles.
If you look at the 50 most volatile days in market history, 47 of them occurred when when the S&P500 was below the 200-day moving average. While nobody knows how or when this will end, it is important to reflect on the fact that you can’t have the reward without embracing reasonable risks and losses along the way.
The purpose of a financial advisor is to help people be prepared for many unforeseen futures - not just in the markets, but other aspects of their lives.
So, after seven bad weeks, we have had a bit of a rebound. Is it a head fake? Head fake or not, what can be done to take advantage of the current, unfavorable conditions?
If you are disciplined, you are likely doing fine by doing very little. That said, there are some things that can make a difference, but not something you would see and feel immediately. Progress happens too slowly to notice, while setbacks happen too quickly to ignore the temptation to act. Here’s where to start.
Increase your savings rate and contribute more to the appropriate accounts. I can make the argument that many stocks and the market as a whole are still expensive, but they are less expensive that they were five months ago, and I don’t know when the market will rebound, so I’m willing to contribute to my accounts and take advantage of this Wall Street Sale, while other run for the door that were willing to pay when it cost them 15% more than today. How does this help you? Look at this chart from Ned Davis Research. If you started buying close to the 2000 Peak, look what it did to your returns.
Manage your expectations. A well diversified portfolio over the course of the past 15 calendar years likely has experienced two years of close to 0% returns, one decline of 6%, one 12% loss, and a 30% drop in their portfolio value. However, over those 15 years, an 8% annualized return wasn’t unreasonable.
How many summers do you have left with your kids? How many years of independent mobility do you have?
This market drama is a distraction. It’s the price that long-term investors have to pay for the performance we have had since 2009. . You’ve got a front row seat and it has a price… if you’re willing to pay it. Stock market history says it is in the long-term, but not everyone can and not everyone will be willing to pay.
We don’t live in 15 year increments. Our attention cycle has a shorter half-life than milk. We live in increments of today, and maybe tomorrow, and that means that is going to hurt and nothing hurts worse than pain.
If you can change your expectations and zoom out, what does this mean for you? Tell me your goals and timeframe as a starting point. If you don’t know what you’re trying to achieve by putting money at risk in the market, then how can you know how a particular market move might affect you?
So what’s going to happen next? I don’t know, but it’s likely less complicated than you think. With history as my guide, human nature never changes. We’ll see massive up days – where sellers melt away and stocks look like they’ve seen the worst. You’ll also see painful descents - everything down and nowhere to hide. These microbursts will go on for a while, until they don’t. The damage will have been done, but a lot of potential opportunities get created as a result.
Who wins? The person who is disciplined, has a process, and does little. Don’t be the human behavior that my models try to arbitrage - be on the side of capitalizing on detrimental human nature.
Buy with purpose and automate good behaviors. With any market drop, Is this a 5 week pullback, a five month pullback, or a 5 quarter slog, Begin by saying “I don’t know and that’s okay, because nobody else does”. In doing so, realize you can’t go “all in” at once. You have to ask humbly “what if I’m wrong”. You can automate and codify buying based on the calendar or the price level.
Rebalancing is free and easy, but it only works, of course, if you have a target allocation in the first place. The good news is you can do this any time. Over time, rebalancing is the only way to buy low and sell high without guessing. Yes, stocks may go down further from here, but the beauty of long-term investing is that you don’t have to time it perfectly. There is no prize for being first.
Take Tax Losses in some positions you own may be below your original purchase price. If you sell these positions, you book a tax loss that can be used to offset capital gains either this year or in the future. You cannot buy the same security back within 31 days to avoid running afoul of the IRS wash sale rule. That doesn’t prevent you from reinvesting in something similar to maintain asset allocation disceipline. Sell a recent Amazon or Target purchase and buy a Large Cap index. Sell a bond index purchase and replace it with a different type of bond. Your tax losses are an asset. They will reduce your capital gains tax if you . harvest them.
Executing a Roth Conversion is best done when the market has dropped. The tax owed on a ROTH conversion is calculated based on the value of the conversion. Why not convert more shares at a lower tax cost? Ideally, the new ROTH will participate in the market’s recovery, resulting in a larger ROTH with less tax paid. This isn’t about doing the conversion at an attempted timing of the market bottom. It is about doing the conversion based on a lower lifetime tax impact at a level that you understand said impact. This may be equally important for your parents to do if you don’t want a huge inherited IRA added to your annual tax bill.
There are other things you can do. GRATs, Family Gifts to name a few. But buy an income or capital appreciating asset even if in the short term, it doesn’t work out. The key is to remember - this too, will pass.