Who Knows?

This week marks the 30-year anniversary of Black Monday when the Dow Jones Industrial Average fell 508 points or 22.5% and experts are still searching for answers as to why the market crashed.  The culprit has been pinned on portfolio insurance which is ironic because portfolio insurance is designed to protect portfolios when stocks fall.  Professional investors needed a villain because they couldn’t tell their clients they didn’t have a reason for the stock market correction so portfolio insurance has been accused of the crime.  However, no one really knows why the market fell on that dark day in October.

Last week Richard Thaler was awarded the Nobel prize in economics for his study of behavioral economics and finance.   He studies the psychological side of economics and tries to understand why investors behave in certain ways.  In his book Misbehaving he said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

Confidence runs high on Wall Street because investors want answers, they want the truth.  CNBC commentators, money managers, traders, and pontificators give surefire forecasts.  These experts claim to know the direction of stock prices, interest rates and oil.   They’re not only certain in the direction of their trade but they also know when it will happen.   These individuals have big microphones and a wide audience so their word is accepted as Gospel like Adam Sandler in the Wedding Singer, “Funny, I have the microphone and you don’t so you will listen to every damn word I have to say!”

When their predictions don’t work or fall short, their explanation is usually blamed on some unforeseen event, an event no one could have foretold.   The unseen event is why no one will ever be able to predict market moves.  After all, if we knew an event was going to happen, we’d take steps to protect ourselves against the event.   For example, Warren Buffett sold 90% of his Walmart holdings during the fourth quarter of 2016.[1]  Walmart is up 15.25% for 2017.  Do you think the greatest investor of all time would have sold Walmart if he knew it would rise 15%?

Wall Street is not alone in their definite predictions.   College pre-season football analyst, political pundits and weatherman join the list of experts who must be right early and often.  The listening audience wants to know the experts are in control and all knowing.

I’m an advisor and financial planner so I’m supposed to know the unknown.  I’m supposed to be certain in a sea of uncertainty.   Predicting the direction of the stock market should be easy like trying to forecast the flight pattern of a butterfly on a windy day or the spending habits of teenagers.   I want to have all the answers but I don’t.  I don’t know what will happen tomorrow let alone ten years from now.

Despite the ambiguity of forecasts and predictions, I do know a few things that can give you a long-term advantage.

  1. Save more and spend less. You control how much money you spend and how much money you save.   If you save more than you spend, your assets will grow.
  2. Plan for success. A financial plan can give you a framework to help strengthen your financial foundation.   Your plan can help with things like retirement or education.
  3. Stocks outperform bonds. For the past 90 years stocks have outperformed bonds by a ratio of 45:1.   If bonds are worth $10,000, then stocks are worth $450,000.   If your time horizon is longer than 10 years, you’d be wise to own a large basket of stocks.[2]
  4. Diversification will reduce risk. A portfolio allocated across large, small and international stocks mixed in with bonds and cash will reduce the risk for your investments.  For example, a portfolio with 60% stocks and 40% bonds and cash will reduce your risk 35% when compared to an all stock portfolio.[3]
  5. Time wins. A long-term view will improve your investment results.  Trying to time the market or actively trade your account is a loser’s game.  Over 20-year rolling periods (1980 – 2000, 1981 – 2001, and so on) the stock market has made money 100% of the time.  Since 1926 there have been 72 rolling periods.[4]
  6. Rebalance your account.  Rebalancing your account will help reduce risk and keep your original asset allocation in check.   For example, if you start the year with a portfolio of 60% stocks and 40% bonds and by the end of the year it moved to 80% stocks and 20% bonds, it should be rebalanced back to your original 60%/40% split.

For the record, if you invested $100,000 in the Vanguard S&P 500 index fund on October 19, 1987, your investment is now worth $2,100,000 and generated an average annual return of 10.71%.[5]

Will the stock market crash soon? Who knows?

“The market can stay irrational longer than you can stay solvent.” ~ John Maynard Keynes.

“Therefore, keep watch, because you do not know on what day your Lord will come. ~ Matthew 24:42

Bill Parrott is the President and CEO of Parrott Wealth Management.  For more information on financial planning and investment management please visit www.parrottwealth.com.

October 14, 2017

Note: Your returns may differ than those posted in this blog and past performance is not a guarantee of future performance.  Securities involve risk and are not insured or guaranteed.

 

[1] http://www.businessinsider.com/why-warren-buffett-sold-walmart-2017-3, John Szarmiak, March 13, 2017.

[2] Dimensional Fund 2017 Matrix Book.

[3] Riskalyze

[4] Ibbotson®SBBI® 2015 Classic Yearbook.

[5] Morningstar Office Hypothetical Tool, 10/19/1987 – 9/30/2017.

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