One of the illogical realities of the investment business is that it enjoys a unique distinction - when our inventory goes on sale, there a very few buyers. Plaster a “30% off” sign on shoes, cars, or refrigerators and shoppers willingly take advantage of the deal. Put that same “30% off” sign on the S&P 500and buyers go wanting.
Investors have enjoyed a long period, approaching 100 months, without a 20% decline in the S&P 500 index. The VIX Index, an accepted indicator of stock market volatility, is currently trading around 10, very close to historical lows. Despite political turmoil at home and abroad, saber rattling from North Korea, and the ever-present threat of global terrorism, the stock market has continued a steady climb. (For more, see: Are Equity Markets Overvalued?)
Cause for Concern
Given all the positives, why should advisors and investors be concerned? A lack of normal volatility in the market may have created a false sense of complacency among investors, especially younger investors who haven’t experienced typical equity market swings. The average intra-year decline in the market going back to 1980 is about 14%. However, the last seven years that average has been less than 9%, and the market hasn’t been in negative territory at all in 2017. That’s not a prediction, just perspective.
I believe the most important trait successful investors possess is rational optimism. While the long-term return of capital markets are almost assuredly something above the rate of inflation, the near-term direction is impossible to predict. I’d contend it’s far better to provide clients with some perspective on market declines before they occur. The time to count the life boats is before they are needed.
An Investment Life Boat Drill
What does an investment life boat drill entail? For starters, a review of one’s investment objective or asset allocation. Some clients have a tendency to shift their risk appetites in tandem with the direction of the market, preferring more equity exposure when skies are clear and less when storm clouds are on the horizon. We advise clients to set an equity allocation they can stick with in good times and bad and periodically rebalance. This helps clients to buy low and sell high.
Secondly, does the client have sufficient cash reserves to weather a 10% or greater market decline? Our firm encourages retired clients to maintain 12-18 months of living expenses in a cash reserve fund. Should the equity market decline more than 10%, we suspend portfolio distributions and use the cash reserve account for living expenses. Since 1960 the average bear market (>20% decline) has lasted about 16 months. Using the cash reserve account during market declines helps our clients avoid selling assets at depressed prices and helps maintain investment discipline.
Finally, it’s important to remind clients that capturing capital market returns requires embracing volatility. Returns above the risk-free rate require, by definition, taking risk. If equity returns were risk-less they’d certainly be a lot lower. We like to show clients how volatility gradually smoothes out over longer time periods with monthly, quarterly, yearly and 10-year period charts. This visual helps reassure clients that whatever happens in the future, it’s something we’ve likely experienced before.
ไม่มีความคิดเห็น:
แสดงความคิดเห็น