February 2020 Monthly Insight – Embracing Volatility

Posted By T. Lee Sherbakoff, CPA/PFS, CFP® on Feb 1, 2020


“Don’t underestimate the value of doing nothing”

—A. A. Milne, an English author, best known for his books about the teddy bear Winnie-the-Pooh

We hope all is well with you so far in the New Year.

You have likely heard us plead the case that we must embrace volatility if we are going to invest in the stock market. The fact that markets swing suddenly at times is why they allow for higher returns than the low, steady rates you earn on money markets and savings accounts. When nervous, deluded investors bail out, it leaves significant growth opportunities for those who stay the course.

How do we prepare for the certainty of down markets? We must prepare ourselves financially, but more importantly we must prepare both mentally and emotionally. By our count, there have been 15 “bear markets” in equities since the end of World War II—an average of one every five years or so. The average depth of these declines was something on the order of 30%. But back in September of 1945, the forerunner of the S&P 500-Stock Index was around 16, while the Index ended this past year at 3,231. Thus, at least historically, the permanent advance has triumphed over the temporary declines.

Since we accept that market timing doesn’t work, the only way to capture the full premium return of equities is to ride out their frequent—but ultimately temporary—declines. We are long-term equity investors, working steadily toward the achievement of our most cherished lifetime goals. We make no attempt to forecast or predict the equity market; indeed, we believe that to be nonsensical.

Regardless of equity volatility, you still may need cash to meet short-term needs. How much short-term safe money you need depends not just on your spending needs, but also on your own “risk” aversion.  We put “risk” in quotes because the investment industry has defined risk as short-term market volatility. For individuals prepared to stay the course in the face of mass media induced hysteria, risk is simply not having enough money when you need it, whether this year, next year, or even the year after. The amount you need in short-term holding is a personal decision we work together to identify.

We want to remind you, as we so often do, that the average annual drawdown in the S&P 500 has, since 1980, been 13.8%, and that despite this, the price-only return of the Index has been positive in 30 of those 40 years. Thus, we’ll do well to bear in mind that (a) corrections are quite common, (b) neither we nor anyone else can forecast, much less time, them, and (c) they are irrelevant to our investment policy, which is long-term, goal-focused and planning-driven.

It is overwhelmingly probable that 2020 will not match the returns of the past year. This is not to be taken as any sort of market forecast. (As we’ve always said to you, we are planners, not prognosticators.) It is simply an invitation, as we look into the New Year, to take some comfort from the rampant fear abroad in the land, even after a decade and more of stellar returns.

The fact is that goal-focused, planning driven investors had an exceptional year in 2019. We did so not by forecasting this year’s returnsnor by jumping into the market just in time to get them—but by patiently adhering to our long-term equity discipline. That, to us, is the great lesson of this remarkably great year.

Here is what we want you to take away from this exercise: When you read those headlines that strike fear in your heart, just remember 2019. Remember the over-hyped concerns and pessimism constantly promoted in the news. Then smile a little and rest easy knowing that doing nothing, with intent and purpose, is in fact doing something. Yes, the next time could end up worse for the year, but a year is an arbitrary measure of time. And always remember this—if it hasn’t ended well then it isn’t over yet. Optimism is a far better approach to investing than pessimism.

It’s worth restating our overall principle of investment advice: Remain goal-focused and planning-driven, rather than adopting an approach that is market-focused and current-events-driven. Long-term investment success comes from continuously acting on a plan. Investment failure is the result of continually reacting to current events in the economy and the markets.

Our essential principles of goal-focused portfolio management remain unchanged. (a) The performance of a portfolio relative to a benchmark is largely irrelevant to long-term financial success. (b) The only benchmark we should care about is the one that indicates whether we are on track to accomplish our financial goals. (c) Risk should be measured as the probability that we won’t achieve our goals. (d) Investing should have the exclusive goal of minimizing that risk.

We look forward to working with you this coming year and commit always to act in your best interest and strive to earn the trust and confidence you have placed in us.