February Market Update

For the investor looking for market details and explanations, this February Market Update article is for you.  Broad market index and tech stock investors were in command throughout January, even as the month ended with a Federal Reserve (Fed) meeting taming some potentially over-enthusiastic March rate cut bulls. 

 

With the tech and major market index rally continuing its run since November, I thought now would be a good time to inform you of the latest developments set to impact Americans in the months ahead. 

 

Major Stock Indexes

 

January was good for long-term investors in U.S. stocks, especially in large tech with AI exposure.  If you haven’t heard of Nvidia before, you will from now on.  Market bulls (ie, investors expecting the market to continue its run upward) were cheering the prospects of a more accommodating Fed in 2024, with the rate decision and Fed statement happening on the last day of the month. 

 

For the month of January, the S&P 500 added 1.59%, the Nasdaq 100 tacked on 1.82%, and the Dow Jones Industrial Average rose by 1.22%.

 

Mixed/Slowing Inflation Signals

 

The overall trend for inflation was mixed in January, even as Consumer Price Index (CPI) data came in a bit hot.

 

CPI: The December Consumer Price Index showed a 0.3% monthly increase in December and a 3.4% increase versus one year ago. Estimates were for a 0.2% monthly gain in December and a 3.2% gain year-over-year. Shelter and services pricing remained sticky.

 

PPI: For December, the Producer Price Index report came in below expectations, indicating mixed signals on the inflation front.

 

According to the report, wholesale prices declined by 0.1% month-over-month in December, lower than the expected gain of 0.1% estimated by Dow Jones economists.

 

PCE: According to the most recent Core Personal Consumption Expenditures (PCE) release, the rate of price increases slowed down as 2023 came to a close. 

 

The Fed’s preferred inflation indicator showed that prices were higher by 0.2% month-over-month in December and by 2.9% year-over-year. Dow Jones economists had expected respective increases of 0.2% and 3%. However, digging a little deeper and looking at the three and six-month averages of Core PCE on an annualized basis, we see it running under 2% (note: the Fed’s Target is 2%). This data, noted by former Vice Chair of the Federal Reserve Lael Brainard and provided by the Bureau of Economic Analysis, has inflation watchers cheering the current market environment.

 

Fed Put?

 

In plain English, a “Fed put” means that the Fed is standing by to change policy if needed, should the equity markets experience declines.  At present, it feels like there are the makings of a Fed put under the market. If storm clouds arise, the market is expecting the Fed to “come to the rescue” with rate cuts in 2024 if needed.  The market was expecting six rate cuts in 2024 before the January Fed meeting, even though the economy has been performing well as of late. This outlook is not the norm. Historically, rate cuts are seen in struggling or downtrodden economies that need stimulation.  The January Fed meeting tempered expectations for a March rate cut, with probabilities declining from 50% to 35.5% on January 31. However, it is still early in this election year, so pay attention.

 

This idea of a Fed put is a concept, not a guarantee, and seemed to be on the mind of many market participants at the start of February, indicating that the collective market mindset could be that any pullbacks may be short-lived.

 

Treasury Yields Steady in January

 

The widely monitored 10-year Treasury note yield was close to unchanged for the month of January, closing the month near 3.966% — about 10 basis points higher than December’s closing level near 3.865%.  This is the yield most closely tied to the movement of mortgage rates, so it is watched closely.  January marks two consecutive monthly closes below 4.00% in the 10-year yield.  The steadiness in rates is good news for sidelined prospective mortgage borrowers and great news for long-term investors in U.S. equities.

 

Fed Rate Decision

 

The last day of January gave us the first Fed meeting of 2024, as the Fed left interest rates unchanged in line with market expectations.  There were some changes to the Fed’s statement, however, as Federal Reserve Chair Jerome Powell seemed to want to tame the market’s excitement for a March rate cut.  “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting to cut rates,” Powell said.  The verbal statement indicating that a March rate cut is not likely poured some water on the fire of potentially overly enthusiastic stock market bulls as the major averages pulled back during and after Powell’s commentary.  Powell did signal rate cuts at some point in 2024, however.  “It will likely be appropriate to begin dialing back policy restraint at some point this year,” said Powell.

 

Pretty vague, huh?  Fed-speak is one of the hardest languages to learn!

 

Consumer & Employment Strong

 

Consumer health metrics remained strong during January, even as many analysts expect the consumer to “tap out”.  At the same time, labor market data exceeded expectations for December, showing 216,000 jobs created. Government jobs and health-care-related fields led the way.

 

Starting the month of February, the latest employment report blew away all expectations, showing 353,000 jobs created in January versus 185,000 estimates by Dow Jones. The labor market continues to surprise to the upside, and the market reaction was an interesting one.

 

January Labor Data Market Reaction

 

While the massively better-than-expected January jobs data indicates a stronger economy, it also shows that the economy may still be running hotter than the Fed wants to see. This reinforces the logical probability that a March rate cut could be off the table.

 

Major U.S. stock indexes didn’t seem to mind, though, as they cheered the data by trading to the upside on the day of. The jobs report was released the morning after positive earnings results from Meta (Facebook), Microsoft, and Amazon. So, perhaps this earnings effect outshined the March rate cut odds everyone seemed to be so fixated upon just a day before.

 

The probability for a March 25-basis-point cut was all over the place at the end of January and beginning of February, resting at a 20% chance on February 1 after sitting at a 46.2% chance on January 26th, according to the CME FedWatch Tool.

 

Is the economy still too hot? What do the continuing and massive upside surprises in the job market mean for inflation?  This is interesting data for short term speculation, but as you have heard many times in the past, short term data is not very helpful in making long term decisions with your investments.  Pay attention to these data points, if you find it interesting, but don’t let any of it sway you from your financial planning course.

 

Q1 Letter to Clients

If there’s a message to take from 2023 markets, it is this: Timeless wisdom best informs timely decisions.

Here’s how Morgan Housel describes the same in his new book, “Same as Ever.”

“The typical attempt to clear up an uncertain future is to gaze further and squint harder—to forecast with more precision, more data, and more intelligence. Far more effective is to do the opposite: Look backward, and be broad. Rather than attempting to figure out little ways the future might change, study the big things the past has never avoided.”

Following are a few timeless tenets that offer timely investment insights for the year ahead.

There’s Never a Good Time to Time the Market

Perhaps most obviously, last year demonstrated how randomly—and rapidly—markets can move. As The Wall Street Journal reported at year-end:

“Almost no one thought 2023 would be a blockbuster year for stocks. They could hardly have been more wrong.”

Another financial journal observed:

“What was supposed to go up went down, or listed sideways, and what was supposed to go down went up — and up and up. The S&P 500 climbed more than 20% and the Nasdaq 100 soared over 50%, the biggest annual gain since the go-go days of the dot-com boom. … ‘I’ve never seen the consensus as wrong as it was in 2023,’ said Andrew Pease, the chief investment strategist at Russell Investments.”

Many financial pundits offered elaborate explanations for the year’s fortunes, and why (in hindsight) their projections were so far off. While their reasons may be accurate, the implication is, were it not for this, that, or the other thing, their forecasts would have been correct.

The problem is, there’s almost always “this, that, or the other thing” going on in this big, busy world. Thus, it really should come as no surprise that routine surprises regularly randomize the market’s next moves.

We’ve known this for years—since at least 1973, when Burton Malkiel published the first edition of “A Random Walk Down Wall Street.” Even after 50 years, Malkiel’s message represents one of the most timeless truths explaining why we don’t try to time market trends.

Beware of Catchy Catchphrases

In 2023, just seven stocks within the S&P 500 Index explained almost two-thirds of the index’s total annual gains. Their striking performance scored them the catchy title, “Magnificent Seven.”

What should we expect for this star lineup in the coming year? Search today’s popular press, and you’ll find timely tips galore on whether to bulk up on more magnificence, or sell while the selling is good. Forecasts hinge on the usual suspects: Whether inflation rises or falls, a recession lands or recedes, technologies advance or retreat, and so on.

Taking a more timeless view, we would suggest being wary of celebrated stocks bearing trendy titles. Chasing after stellar returns with their own nicknames may work for a while. But eventually, one of those “surprises” tends to come along, turning once-hot stocks into cold plays.

Which brings us to our next timeless tenet.

Diversification Is Perennially Prudent

Viewing 2023 up close, there may be a temptation to chase after the market’s recent winning streak, bulking up on more of that which has been so pleasantly surprising of late.

Zooming out, our perspective remains unchanged: Maintain a globally diversified portfolio, tailored for your needs. Treat an allocation to the Magnificent Seven (and the next trend, and the one after that) as one of many “pistons” powering the market’s perennial growth. But pair it with effective diversification, to temper the inevitable upsets that await us in the year(s) ahead.

In this spirit, I wish you a well-diversified investment portfolio in 2024, along with abundant concentrations of health, happiness, and harmonious well-being for you and yours.

 

 

4 Financial Best Practices for Year-End 2023

Scan the financial headlines these days, and you’ll see plenty of potential action items vying for your year-end attention. Some may be particular to 2023. Others are timeless traditions. If your wealth were a garden, which actions would actually deserve your attention? Here are our four favorite items worth tending to as 2024 approaches … plus a thoughtful reflection on how to make the most of the remaining year.  

 

1.     Feed Your Cash Reserves

With basic savings accounts currently offering 5%+ annual interest rates, your fallow cash is finally able to earn a nice little bit while it sits. Sweet! Two thoughts here:

Mind Where You’ve Stashed Your Cash: If your spending money is still sitting in low- or no-interest accounts, consider taking advantage of the attractive rates available in basic money market accounts, or similar savings vehicles such as short-term CDs, or U.S. Series I Saving Bonds (“I Bonds”). Your cash savings typically includes money you intend to spend within the next year or so, as well as your emergency, “rainy day” reserves. (Note: I Bonds require you to hold them for at least a year.)

Put Your Cash in Context: While current rates across many savings accounts are appealing, don’t let this distract you from your greater investment goals. Even at today’s higher rates, your cash reserves are eventually expected to lose their spending power in the face of inflation. Today’s rates don’t eliminate this issue … remember, inflation is also on the high side, so that 5% isn’t as amazing as it may seem. Once you’ve got your cash stashed in those high-interest savings accounts, we believe you’re better off allocating your remaining assets into your investment portfolio—and leaving the dollars there for pursuing your long game.  

 

2.     Prune Your Portfolio

While we don’t advocate using your investment reserves to chase money market rates, there are still plenty of other actions you can take to maintain a tidy portfolio mix. For this, it’s prudent to perform an annual review of how your proverbial garden is growing. Year-end is as good a milestone as any for this activity. For example, you can:

Rebalance: In 2023, relatively strong year-to-date stock returns may warrant rebalancing back to plan, especially if you can do so within your tax-sheltered accounts.

Relocate: With your annual earnings coming into focus, you may wish to shift some of your investments from taxable to tax-sheltered accounts, such as traditional or Roth IRAs, HSAs, and 529 College Savings Plans. For many of these, you have until next April 15, 2024 to make your 2023 contributions. But you don’t have to wait if the assets are available today, and it otherwise makes tax-wise sense.

Revise: As you rebalance, relocate, or add new holdings according to plan, you may also be able to take advantage of the latest science-based ETF solutions.  We’re not necessarily suggesting major overhauls, especially where embedded taxable gains may negate the benefits of a new offering. But as you’re reallocating or adding new assets anyway, it’s worth noting there may be new, potentially improved resources available.

Redirect: Year-end can also be a great time to redirect excess wealth toward personal or charitable giving. Whether directly or through a Donor Advised Fund, you can donate highly appreciated investments out of your taxable accounts and into worthy causes. You stand to reduce current and future taxes, and your recipients get to put the assets to work right away. This can be a slam dunk strategy to avoid an embedded capital gain and get a tax deduction for the full value going to the charity of your choice.  If you have appreciated assets, considering gifting these and holding on to your cash.

 

3.     Train Those Taxes

Speaking of taxes, there are always plenty of ways to manage your current and lifetime tax burdens—especially as your financial numbers and various tax-related deadlines come into focus toward year-end. For example:

RMDs and QCDs: Retirees and IRA inheritors should continue making any obligatory Required Minimum Distributions (RMDs) out of their IRAs and similar tax-sheltered accounts. With the 2022 Secure Act 2.0, the penalty for missing an RMD will no longer exceed 25% of any underpayment, rather than the former 50%. But even 25% is a painful penalty if you miss the December 31 deadline. If you’re charitably inclined, you may prefer to make a year-end Qualified Charitable Distribution (QCD), to offset or potentially eliminate your RMD burden.

Harvesting Losses … and Gains: Depending on market conditions and your own portfolio, there may still be opportunities to perform some tax-loss harvesting in 2023, to offset current or future taxable gains from your account. As long as long-term capital gains rates remain in the relatively low range of 0%–20%, tax-gain harvesting might be of interest as well. Work with your tax-planning team to determine what makes sense for you.

Keeping an Eye on the 2025 Sunset: Nobody can predict what the future holds. But if Congress does not act, a number of tax-friendly 2017 Tax Cuts and Jobs Act provisions are set to sunset on December 31, 2025. If they do, we might experience higher ordinary income and capital gains tax rates after that. Let’s be clear: A lot could change before then, so we’re not necessarily suggesting you shape all your plans around this one potential future. However, if it’s in your overall best interests to engage in various taxable transactions anyway, 2023 may be a relatively tax-friendly year in which to complete them. Examples include doing a Roth conversion, harvesting long-term capital gains, taking extra retirement plan withdrawals, exercising taxable stock options, gifting to loved ones, and more.

 

4.     Weed Out Your To-Do List

I love this one…it is at the top of my improvement goals.  Doing less instead of staying busy with more.  This year, we’re intentionally keeping our list of year-end financial best practices on the short side. Not for lack of ideas, mind you; there are plenty more we could cover.

But consider these words of wisdom from Atomic Habits author James Clear:

“Instead of asking yourself, ‘What should I do first?’ Try asking, ‘What should I neglect first?’ Trim, edit, cull. Make space for better performance.”

— JamesClear.com

 

Let’s combine Clear’s tip with sentiments from a Farnam Street piece, “How to Think Better.” Here, a Stanford University study has suggested that multitasking may not only make it harder for us to do our best thinking, it may impair our efforts. 

“The best way to improve your ability to think is to spend large chunks of time thinking. … Good decision-makers understand a simple truth: you can’t make good decisions without good thinking, and good thinking requires time.”

— Farnam Street

 

In short, how do you really want to spend the rest of your year? Instead of trying to tackle everything at once, why not pick your favorite, most applicable best practice out of our short list of favorites? Take the time to think it through. Maybe save the rest for some other time.

Is the Debt Ceiling Bringing You Down?

What does the U.S. debt ceiling debate really means for you? I am getting this question regularly, which means it is probably on the minds of many more folks.  As potential threats loom large, we’re seeing articles in abundance, explaining where we’re at, how we got here, and what to expect next.

We wouldn’t be human if we didn’t share in your frustration over the maddening lack of resolution to date. It’s stressful to watch huge, consequential events unfolding, over which we have no control. And who needs more stress in their life?

Which is why we encourage you to think of your investments as a bright spot of relief in an otherwise unmanageable world. In the face of everything we cannot control, the one place you can call your own shots is within your well-structured, globally diversified investment portfolio.

And here’s more good news: As an investor, you don’t really need to know that much about the real-time details of the debt ceiling negotiations. Instead, as with any other breaking news, a healthy degree of arm’s length disinterest will likely serve you best, especially if you might otherwise respond to the current fever pitch of news that’s news because it’s in the news.

To illustrate, let’s look behind three different doors to consider your most advisable investment strategy under various outcomes.


Door #1: Opportunistic Agreement

With history as our guide, it is perhaps most reasonable to expect today’s political brinksmanship-as-usual will lead to some form of resolution, probably arriving at the last possible moment. This is exactly how the debt ceiling debate has played out on multiple occasions, with each side of the isle using it as an opportunity to score new political points, and there is no reason to think this time will be any different.  Then what? Most likely, the “fix” will be partial and imperfect, and the hand-wringing will continue apace over the next challenges inherent in the latest patch.  The self-preserving nature of the Congressional representative role seems to always come through to make sure the economy doesn’t screech to a halt.  The talking points might shift, but markets will remain as volatile and unpredictable as ever. In this most likely scenario, we would advise …

Staying invested in your carefully constructed, globally diversified investment portfolio, structured for your personal financial goals and risk tolerances.


Door #2: Meltdown

What if negotiations in Washington fail? What if we experience U.S. credit rating downgrades, debt defaults, and unpaid Social Security benefits (to name a few of the uglier possibilities)? In a worst-case scenario, the U.S. dollar could lose its global currency status, a position it’s held since before most of us were born. What then?

If a worse- or worst-case scenario occurs, our marvelously efficient markets would once again respond by pricing in the good, bad, and ugly news well before we can successfully trade on it. Global diversification would be as important, if not more critical. Selling in a panic as markets adjust to the worsening news would remain as ill-advised as ever. In other words, your advisable course would remain …

Staying invested in your carefully constructed, globally diversified investment portfolio, structured for your personal financial goals and risk tolerances.


Door #3: Proactive, Compromising Agreement

Last, and probably least likely, what if Washington defies our doubts, and achieves a happy and timely debt ceiling resolution, with little to no harm done? Hey, anything is possible. In this best-case scenario, the breaking news would be better than most of us expect, so markets would likely respond at least briefly with better-than-expected returns, rewarding us for staying put. At the same time, just in case the next bit of news were to disappoint, or even be less exciting than expected, we’d want to temper any concentrated market exposures by, you guessed it …

Staying invested in your carefully constructed, globally diversified investment portfolio, structured for your personal financial goals and risk tolerances.

This is by no means a perfect hedge against black swan events, but it’s a good start and would allow for some long-term benefits by taking advantage of stocks in decline through strategic rebalancing.  We would be happy to offer more insights and analysis about the debt ceiling if you are interested in learning more. We’re also here to review your portfolio mix any time your personal circumstances may warrant a change. Otherwise, guess what we would advise you to do while the debt crisis continues? If you’re not sure, please give us a call. We always enjoy hearing from you!

Good advice is simple – but not easy!

Here in North Carolina, we cope with hurricanes from time to time, and like the storms, financial markets can bring bumpy weather to our investment portfolios.

However, unlike with hurricanes, which are typically in the forecast for several days at least,  no one can truly see over the horizon to know when bad times – a big drop in asset values – may affect our investments.  When that happens, it is more important than ever to have, and to follow, a solid financial plan.

Sometimes the best, most rigorously developed financial advice is so obvious, it’s become cliché. And yet, investors often end up abandoning this same advice when market turbulence is on the rise. Why the disconnect? Let’s take a look at five of the most familiar financial adages, and why they’re often much easier said than done.

  1. If you fail to plan, you plan to fail.
  2. No risk, no reward.
  3. Don’t put all your eggs in one basket.
  4. Buy low, sell high.
  5. Stay the course.

We’ll explore each in turn, how we implement them, and why helping people stick with these evidence-based basics remains among our most important and challenging roles.

  1. If You Fail to Plan, You Plan to Fail.

Almost everyone would agree: It makes sense to plan how and why you want to invest before you actually do it. And yet, few investors come to us with robust plans already in place. That’s why deep, extensive and multilayered planning is one of the first things we do when welcoming a new client, including:

  • A Discovery Meeting – To understand everything about you, including your goals and interests, your personal and professional relationships, your values and beliefs, how you’d prefer to work with us … and anything else that may be on your mind.
  • “Traditional” Financial Planning – To organize your existing assets and liabilities, define your near-, mid-, and long-range goals, and ensure your financial means align as effectively as possible with your most meaningful aspirations.
  • An Investment Policy Statement (IPS) – To bring order to your investment universe. Your IPS is both your plan and your pledge to yourself on how your investments will be structured to best align with your greater goals. It describes your preferred asset allocations (such as your percentage of stocks vs. bonds), and is further shaped by your willingness, ability, and need to tolerate market risks in pursuit of desired returns.
  • Integrated Wealth Management – To chart a course for aligning your range of wealth interests with your financial logistics: insurance, estate planning, tax planning, business succession, philanthropic intent and more.

As we’ll explore further, even solid planning doesn’t guarantee success. But we believe the only way we can accurately assess how you’re doing is if we’ve first identified what you’re trying to achieve, and how we expect to accomplish it.

  1. No Risk, No Reward.

In many respects, the relationship between risk and reward serves as the wellspring from which a steady stream of financial economic theory has flowed ever since. Simply put, exposing your portfolio to market risk is expected to generate higher returns over time. Reduce your exposure to market risk, and you also lower expected returns.

We typically build a measure of stock market exposure into our clients’ portfolios accordingly, with specific allocations guided by individual goals and risk tolerances. But here’s the thing: Once you have accepted the evidence describing how market risks and expected returns are related, it’s critical that you remain invested as planned.

There’s ample evidence that periodic market downturns ranging from “ripples” to “rapids” are part of the ride. As a February 2018 Vanguard report described, from 1980–2017, the MSCI World Index recorded 11 market corrections of 10% or more, and 8 bear markets with at least 20% declines lasting at least 2 months. Such risks ultimately shape the stream that is expected to carry you to your desired destination. Consider them part of your journey.

  1. Don’t Put All Your Eggs in One Basket.

At the same time, “risk” is not a mythical unicorn. It’s real. If it rears up, it can trample your dreams. So, just because you might need to include riskier sources of expected returns in your portfolio, it does not mean you must give them free rein.

This is where diversification comes in. Diversification is nothing new. In 1990, Harry Markowitz was co-recipient of a Nobel prize for his work on what became known as Modern Portfolio Theory. Markowitz analyzed (emphasis ours) “how wealth can be optimally invested in assets which differ in regard to their expected return and risk, and thereby also how risks can be reduced.” In other words, according to Markowitz’s work, first published in 1952, investors should employ diversification to manage portfolio risks.

This leads to an intriguing, evidence-based understanding. By combining widely diverse sources of risk, it’s possible to build more efficient portfolios. You can:

  • EITHER lower a portfolio’s overall risk exposure while maintaining similar expected returns
  • OR maintain similar levels of portfolio risk exposure while improving overall expected returns

Rarely, evolving evidence helps us identify additional or shifting sources of expected return worth blending into your existing plans. When this occurs, and only after extensive due diligence, we may advise you to do so, if practical (and cost-effective) solutions exist.

The details of how these risk/return “levers” work is beyond the scope of this article. But come what may, the desire and necessity to DIVERSIFY your portfolio remains as important as ever – not only between stocks and bonds, but across multiple, global sources of expected returns.

  1. Buy Low, Sell High.

Of course, every investor hopes to sell their investments for more than they paid for them. Here are two best practices to help you succeed where so many fall short: time and rebalancing.

Time

By building a low-cost, broadly diversified portfolio, and letting it ride the waves of time, all evidence suggests you can expect to earn long-term returns that roughly reflect your built-in risk exposure. But “success” often takes a great deal more time than most investors allow for.

In a recent article, financial author Larry Swedroe looked at performance persistence among six different sources of expected return as well as three model portfolios built from them. He found, “In each case, the longer the horizon, the lower the odds of underperformance.” However, he also observed, “one of the greatest problems preventing investors from achieving their financial goals is that, when it comes to judging the performance of an investment strategy, they believe that three years is a long time, five years is a very long time and 10 years is an eternity.”

In the market, 10 years is not long. You must be prepared to remain true to your carefully structured portfolio for years if not decades, so we typically ensure that an appropriate portion is sheltered from market risks and is relatively accessible (liquid). The riskier portion can then be left to ebb, flow and expectedly grow over expanses of time, without the need to tap into it in the near-term. In short, time is only expected to be your friend if you give it room to run.

Portfolio Rebalancing

Another way to buy low and sell high is through disciplined portfolio rebalancing. As we create a new portfolio, we prescribe how much weight to allocate to each holding. Over time, these holdings tend to stray from their original allocations, until the portfolio is no longer invested according to plan. By periodically selling some of the holdings that have overshot their ideal allocation, and buying more of the ones that have become underrepresented, we can accomplish two goals: Returning the portfolio closer to its intended allocations, AND naturally buying low (recent underperformers) and selling high (recent outperformers).

  1. Stay the Course.

So, yes, planning and maintaining an evidence-based investment portfolio is important. But even the best-laid plans will fail you, if you fail to follow them. Here, we get to the heart of why even “obvious” advice is often easier said than done. Our rational self may know better – but our instincts, emotions and behavioral biases get in the way.

Three particularly important biases to be aware of in volatile markets include tracking-error regret, recency bias, and outcome bias.

Tracking-Error Regret

When we build your portfolio, we typically structure it to reflect your goals and risk tolerances, by diversifying across different sources of expected risks and returns. Each part is expected to contribute to the portfolio’s unique whole by performing differently from its counterparts during different market conditions. Each portfolio may perform very differently from popular “norms” or benchmarks like the S&P 500 … for better or worse.

When “worse” occurs, and especially if it lingers, you are likely to feel tracking-error regret – a gnawing doubt that comes from comparing your own portfolio’s returns to popular benchmarks, and wishing yours were more like theirs.

Remember this: By design, your factor-based, globally diversified portfolio is highly likely to march out of tune with typical headline returns. It can be deeply damaging to your plans if you compare your own performance to benchmarks such as the general market, the latest popular trends, or your neighbor’s seemingly greener financial grass.

Recency

Recency causes us to pay more attention to our latest experiences, and to downplay the significance of long-term conditions. When an expected source of return fails to deliver, especially if the disappointment lasts for a while, you may start to second-guess the long-term evidence. This can trigger what Nobel laureate and behavioral economist Daniel Kahneman describes as “what you see is all there is” mistakes.

Again, buying high and selling low is exactly the opposite of your goals. And yet, recency causes droves of investors to chase hot, high-priced holdings and sell low during declines. Irrational choices based on recency may still turn out okay if you happen to get lucky. But they detour you from the most rational, evidence-based course toward your goals.

Outcome Bias

Sometimes, even the most rational plans don’t turn out as hoped for. If you let outcome bias creep in, you end up blaming the plan itself, even if it was simply bad luck. This, in turn, causes you to abandon your plan. Unfortunately, it’s rarely replaced with a better plan, which brings us back to our first adage about those who fail to plan.

To illustrate, let’s say, several years ago, we created a solid investment plan and IPS for you. At the time, you felt confident about them. Since then, we’ve periodically refreshed your plan, based on your evolving personal goals, perhaps a few new academic insights, and any new resources now available for further optimizing your portfolio.

Now, let’s say the markets disappoint us over the next few years. Ugly red numbers take over your reports, seemingly forever. Before you conclude your underlying strategy is wrong, remember: It’s far more likely you’re experiencing outcome bias (with a recency-bias chaser).

Investing will always contain an element of random luck. From that perspective, in largely efficient markets, your best course remains – you guessed it – to stay the course with your existing, carefully crafted plans. While even evidence-based investing doesn’t guarantee success, it continues to offer your best odds moving forward. Don’t lose faith in it.

 Simple, But Not Easy

Let’s wrap with a telling anecdote. Merton Miller was another co-recipient of the aforementioned 1990 Nobel prize. Miller’s portion was in recognition of his “fundamental contributions to the theory of corporate finance.” While his findings were deep and far-reaching, he once summarized them as follows:

[I]f you take money out of your left pocket and put it in your right pocket, you’re no richer. Reporters would say, ‘you mean they gave you guys a Nobel Prize for something as obvious as that?’ … And I’d add, ‘Yes, but remember, we proved it rigorously.’”

Like Miller’s light take on his heavy-duty findings, some of what we feel is our best advice seems so simple. And yet, in our experience, it’s very hard to adhere to this same, “obvious” advice in the face of market turbulence.

Blame your behavioral biases. They make simple advice deceptively difficult to follow. We all have them, including blind spot bias. That is, we can easily tell when someone else is succumbing to a behavioral bias, but we routinely fail to recognize when it’s happening to us.

This is one reason it’s essential to have an objective, professional advisor (along with your network of informal advisors) who is willing and able to let you know when you’re falling victim to a bias you cannot see in the mirror. At PLC Wealth, that is exactly what we are here for! Let us know if we can help you reflect on these or any other challenges that stand between you and your greatest financial goals.

Global Diversification is Your Investment Antacid

Let’s be clear: We did not wish for, nor in any way cause a tumble in the markets, especially among tech stocks. That said, we could not have come up with a more telling illustration to underscore the perennial value of building – and maintaining – a globally diversified investment portfolio for achieving your greatest financial goals.

Global diversification is such a powerful antacid for when (not if!) we experience market turbulence, it’s why we’ve long recommended spreading your market risks:

  • According to your personal goals and risk tolerances
  • Between stock and bond markets
  • Among evidence-based sources of expected long-term returns
  • Around the world

In short, broad, global diversification never goes out of style.

Breaking news shows us why.

Just a few short days ago, third quarter market performance numbers were rolling in, and we were fielding questions about the wisdom of continuing to participate in worldwide stock and bond markets. Some globally diversified investors were beginning to question their resolve after comparing their year-to-date returns to the U.S. stock market’s seemingly interminable ability to whistle past the graveyards of disappointing, portfolio-dampening performance found elsewhere.

Some were asking: “Should we dump diversification, and head for the ‘obviously’ greener pastures watered by U.S. stocks?”

We aren’t the only ones advising investors against reacting to hot runs by turning a cold shoulder to their well-structured portfolio. In his timely September 28 column, Wall Street Journal personal finance columnist Jason Zweig commented: “Looking back in time from today, U.S. stocks seem to have dominated over the long run only because they have done so extraordinarily well over the past few years.”

As current conditions starkly show, there’s a reason for the expression, “Things can turn on a dime.” Whether it’s U.S. stocks, international bonds, emerging markets or any other sources of expected return, the evidence is clear: Trends rise and fall among them all. This we know. But precisely when, where, how much, and why is anybody’s guess. As Zweig suggests in his piece, “Markets tend to lose their dominance right around the time it seems most irresistible.”

What’s next?

We’re drafting this message to you Wednesday evening, October 10, in advance of what may be a wild ride for the next little while. By the time you’re reading this, prices may still be tumbling, or they may already have recovered their footing. We can’t say.

Come what may, we hope we can be particularly helpful to you at this time.

Have current conditions left you troubled, unsure of where you stand?

Let’s talk. We’ll explore whether you’re able to sit tight with your existing strategy, or whether we can help you think through any next steps you may be considering. Most of all, know you are not alone! We are here as your sounding board and fiduciary advisor. Your best interests remain our top priority.

Are you reflecting calmly on current events, recognizing that market volatility happens?

Allow us to applaud you for your stamina, and remind you: Current conditions likely represent a time for continued quietude, along with ongoing attention to managing your tailored portfolio.

Regardless of your temperament, we’d like to share a sentiment from Behavior Gap author Carl Richards’ 2015 New York Times column.  His point remains as relevant as ever:

“On a scale of 1-10, with 10 being abject misery, I’m willing to bet your unhappiness with a diversified portfolio comes in at about a 5, maybe a 6. But your unhappiness if you guess wrong on your one and only investment for the year? That goes to 11.”

Let’s be in touch if we can answer any questions or scale down any angst you may be experiencing.

Regards,

Your PLC Wealth Team