I am going to make a bold promise. I promise to never send you an urgent newsletter or blog post about a bad day or possibly even week in the stock market.
As a financial planner, one of my goals is to help investors build diversified investment portfolios. A diversified portfolio will more than likely underperform the S&P 500 every other year. Yes, here it is up front, every other year I expect for your portfolio to lag behind the S&P 500.
The inherent risk of investing in the stock market also means we need to be prepared for the points in time when our portfolio will lose value. I don’t expect portfolios to always generate positive returns. We cannot have market or portfolio returns without taking on the inherent risk that comes with investing. Our ability to withstand the potential for loss is what will ultimately help our portfolios continue to grow.
The most crucial aspect of investor behavior occurs during down markets. When the market is down, that is when the uncertainty, anxiety, and fear about our investments is at the highest; that is when it is most crucial to step back, take a few deep breaths, and really evaluate if anything in our lives has changed where we need to abandon or change our financial plan. Most investors become ready to sell as they watch their account balances drop because they can’t stand to see the diminished values on their statement. But at this point in time, we are only experiencing a perceived loss. If we don’t act on the urge to cash out, then we are still in the market, we are still in a position to be ready to take part in a market recovery. If we act on these perceived losses, that is when we actually lock the losses into our portfolio.
All of what I’ve just said (well typed out) is understood and known by every investment professional. We know that diversified portfolios will probably lag behind the major market indexes, we know that portfolios will experience volatility, and we know that at times the portfolios we recommend will lose value regardless of how well they are diversified. The press that reports on the stock market knows all of these things too, but a calm attitude toward market downturns, doesn’t sell articles, magazines, newsletter subscriptions, and bring in viewers.
This idea to cause panic isn’t needed because the majority of the activity in the stock market is the known risk that comes with being an investor. Why would I need to send out a newsletter telling you about a down day on the market, when down days are to be expected? Market corrections are to expected, nobody knows when these events will occur or how long they may last, but that is why it is crucial to invest in a diversified portfolio.
The link below illustrates the randomness of returns on a wide range of asset classes. As you can see the returns are not very predictable. I’m not going to attempt to guess which one of these sectors is going to be this year’s best or worst asset class. There are too many variables involved for me to even consider trying to make a prediction, so instead of trying to guess, I use sound financial principles to design diversified portfolios to help capture a wide range of asset class and sector returns.
My goal for every client engagement, is to set realistic market expectations before we even begin talking about investments. The main reason I would have to send out letters to calm investors would be if I wasn’t taking the time to explain to you about the expectations for portfolio returns and the importance of diversification at the beginning.
Have a great weekend,