Headwinds

The stock market has hit a rough patch recently, falling 5.75% since the Federal Reserve cut interest rates on July 30. Headwinds have been stout as market participants react to the trade war, protesters in Hong Kong, Brexit, Trump’s tweets, and calculated language from Chairman Powell.

The recent selloff follows the May decline when stocks fell 7%. For the past 50 years, the average decline from a market top has been 10.7%.[1]

Are this year’s headwinds worse than in previous years? You might say yes because of recency bias. However, it’s in-line with previous market pullbacks.

Here are a few facts.

  • The Dow Jones is up 9.23% for the year and 171% for the past ten.
  • International markets are up 4.32% for the year and 19% for the past ten.
  • Long-term bonds are up 20.8% for the year and 57% for the past ten.
  • A globally diversified portfolio of stocks and bonds (60% stocks, 40% bonds) is up 10% for the year and 104% for the past ten.
  • The 30-Year U.S. Treasury bond is currently yielding 2.03%, a historic low. In 1990, it paid 8%.
  • The current U.S. inflation rate is 1.81%. In 1980 it was 14.5%.

Let’s review how a 60% stock, 40% balanced index performed during past routs if you held on until the end of last year.[2]

  • Stocks fell 48% from 1973 to 1974. If you purchased the index before the drop, your average annual return was 10.4%.
  • Stocks fell 19% in 1990 during the Gulf War. If you purchased the index before the drop, your average annual return was 8%.
  • Stocks fell 43% during the Tech Wreck. If you bought the index in 2000, before the drop, your average annual return was 6.8%.
  • Stocks fell 53% during the Great Recession. If you bought the index in 2007, before the drop, your average annual return was 4.7%.

Markets turn quickly, so it’s best to own a globally diversified portfolio of low-cost funds.

I understand that emotions trump facts when stocks fall 500 points or more. It’s human nature to want to sell your investments and wait for trouble to pass. When fear is high, investors want to trade stocks for bonds until the coast is clear. If you invest in a portfolio of U.S. Treasuries, your current yield would be approximately 1.8%, or about the rate of inflation, so after subtracting inflation, your net return would be zero. It will be less than zero after paying taxes on the income you received.

Are you concerned about the loss of your principal? If so, here are a few steps you can employ today.

  • Reduce your stock exposure. If your stock allocation is 60%, lower it to 40%. Lowering it will reduce your risk by 25%.
  • Increase your cash position to cover three years’ worth of household expenses. If your annual expenses are $100,000, keep $300,000 in cash or short-term investments. A three-year cash cushion will allow you to ride out most market corrections. For example, if you had a high cash reserve from October 2007 to October 2010, it would’ve allowed your stock investments time to recover. In other words, you didn’t need to sell your stocks at the bottom of the Great Recession.
  • Rebalance your accounts to keep your allocation and risk level in check. Since stocks and bonds fluctuate, your asset allocation will change if you do nothing. If you started with a 50% stock, 50% bond portfolio ten years ago, it would have a current allocation of 72% stocks, 28% bonds. By doing nothing, your risk level increased by 37%. An annual rebalance will keep your portfolio allocation at 50/50.[3]
  • Buy the dip. It takes courage and wisdom to buy stocks after they’ve fallen dramatically. Investors who purchased stocks in March 2009, after falling 53%, were rewarded with a gain of 322%! An investment of $100,000 is now worth $422,200.[4] Using the past 100 years as a guide, then buying stocks when they’re down is an intelligent strategy.

Investing is a courageous act, especially when your investments are tumbling. Short-term trading, mixed with short-term thinking, will derail your long-term plans. Rather than acting on impulse, focus on your financial plan. A well-designed plan accounts for multiple scenarios, including broad market declines. If you’re not sure how your investments will impact your financial future, give me a call and let’s figure it out.

I believe the market is going to fluctuate. ~ J.P. Morgan

August 15, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

 

[1] YCharts: August 1, 1969 – August 14, 2019

[2] Dimensional Funds 2018 Matrix Book. Returns ending 12/31/2018.

[3] Morningstar Office Hypothetical.

[4] YCharts: March 9, 2009 to August 14, 2019.

How to Survive a Stock Market Correction.

The Dow Jones Industrial Average continues to ascend to new heights.  The higher the market climbs, the more noise you’ll hear about a stock market correction.  At some point those calling for a market correction will be right.  Stock market corrections are typical and occur about every three to five years.   A bear (down) market will last about 18 months while a bull (up) market will run for about 8 years.[1]

How can you protect yourself against a bear market attack?

  1. Don’t panic! A market drop is normal, painful, but normal.
  2. Don’t make any changes to your portfolio during the initial phases of the market correction. Let the market find its footing before you make any major adjustments to your account.
  3. Cash is king. If you have a cash cushion, you’re less likely to make rash decisions regarding your stock holdings.   How much money should you keep in cash?  My recommendation is for you to hold two to three years’ worth of expenses in cash.  If your annual expenses are $50,000, then your cash amount should be in the range of $100,000 to $150,000.
  4. Diversify your assets. A balanced portfolio of stocks, bonds, cash and alternative investments will help cushion the blow from a market drop. During a market drop it’s likely your bonds will perform well.  During the 2008 market mauling long term U.S. government bonds rose 25.9%.[2]
  5. Rebalance your portfolio. By rebalancing your portfolio, you’ll take advantage of lower stock prices.  Rebalancing will allow you to keep your risk level and asset allocation in check.
  6. Eliminate your margin balance. A sure way to lose more than you intended is to use leverage.  If you’ve tapped the margin in your account to buy securities, I would encourage you to eliminate it entirely.   The best way to make a bad situation worse is to employ margin in a down market.
  7. Stay invested.  The two days following the stock market crash of October 19, 1987 the Dow Jones Industrial Average rose 16%.  Despite the dramatic drop of Black Monday, the Dow ended 1987 with a gain and has since risen 1,100%.
  8. Look for bargains. Is it possible your favorite stock is now 25% or 50% cheaper?  If you’re not sure what to purchase, focus on a broad-based index fund.   An index fund will allow you to gain market exposure with the click of your mouse.
  9. Think long term. A bear market lasts about 18 months.  It’s likely you’ll own your investments for years, maybe decades, before you need the money.   Thinking generationally will help get you through the dark days of a market downturn.
  10. Markets recover. The stock market has always recovered – always!  The Dow is currently trading near its all-time high.
  11. Have fun. The market will go up, down and sideways long after we’re gone.  Instead of marinating in a stew of worry get outside and enjoy your friends, family and hobbies.

Stock market corrections come and go.  The market is a long-term wealth creation machine that is occasionally interrupted with a pullback.  If you stick to these tips, you’ll have an opportunity to benefit from the stock markets long term performance.

Even though I walk through the darkest valley, I will fear no evil, for you are with me; your rod and your staff, they comfort me.  ~ Psalm 23:4.

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

March 10, 2017

[1] https://www.forbes.com/sites/robertlenzner/2015/01/02/bull-markets-last-five-times-longer-than-bear-markets/#12745f772dd5, Robert Lenzer, January 2, 2015, site accessed 3/10/17.

[2] Dimensional Fund Advisors 2016 Matrix Book.