For many people, the stock market can be a daunting and confusing place. Even those with a high level of financial literacy can feel intimidated by this side of the monetary world, that can often feel more like a distant planet.
Many of our clients have been asking for more help in understanding investments and investing. I thought I’d answer a question I’ve been hearing more recently – “how long will these market highs last?”
DECIPHERING THE HIGHS
It’s important to remember that individual stocks on the market will go up and down based on their own merit, supply, and demand. Despite this individual fluctuation, the stock market is often reported as a single thing. Financial reporters media will often refer to behavior of “the stock market” as a whole, when they really mean one of the market indexes.
Simply put, if there are more buyers than sellers, a company’s stock price will go up, and if there are more sellers than buyers, it will go down; the same goes for the market as a whole.
There are numerous indices, but the most widely known are perhaps the Dow Jones and the Standard and Poors 500 index. So when you hear people say the stock market broke a record high, they mean that one of the indices is higher than it has ever been.
In 2017, both continue to hit record highs; but we like to refer to the S&P 500 because it is more reflective of the actual economic output of the 500 underlying companies. While the Dow Jones is the oldest index, it only represents 30 companies and is weighted by the price of the stock rather than the size of the company. In real life, the size of the company (also known as market cap weighted) is going to have a bigger impact on the economy than the price of the stock.
BUT THEY SAID ON THE NEWS…
You’ve likely seen in the news that the U.S. stock markets hit a number of new highs in 2017, and it looks like there is no end in sight. Stocks like Apple – a company we’re all very familiar with – seem to defy gravity with new highs almost daily.
But, as with all things, the party won’t last forever. As an example, we saw the Dot Com bubble burst in mid-2000, followed by a 49% market decline (as measured by the S&P 500 index).
This downward trend stretched way into 2002, fueled in part by the 9/11 tragedy. In our more recent memory is the financial crisis of 2008 which resulted in a steep market decline of 57% lasting about 19 months through early March of 2009.
TIDES OF CHANGE
The stock market tides ebb and flow on a daily basis. Sometimes the waves crash, and at other times the waters are calm and inviting. So what if you did nothing during the last financial crisis and just left your investments alone? Since that 2009 low, the S&P 500 has risen up again by an astounding 272% through September 30, 2017.
Though changes in the stock market, as in all things, are inevitable, nobody can forecast where the stock market is headed and when it will get there. History does tell us that we are likely to experience a pullback of some magnitude at some point in the future. A correction is defined as a decline of more than 10%, and importantly – it happens on average once every fourteen months.
We believe markets are rational over the long term – but in the short term they can be driven by investor sentiment – which simply means the investor’s “mood.” Are there more buyers or sellers? Are people more confident things are good or getting better, or is the majority pessimistic about the future.
This is where Warren Buffett’s quote “Be fearful when others are greedy and greedy when others are fearful” becomes helpful. This mantra can be contrary to our natural thought process.
The most successful investors are those that are able to act upon a plan, rather than to react to the short term swings of the stock market. So what should you do to prepare for the inevitable correction?
REVIEWING YOUR SITUATION
While stock market records undoubtedly make good headlines, they are not uncommon, nor a reason to change your investing strategy. Though it can be tempting to panic and act in haste, our advice is not to do anything major or drastic. Rather, we suggest taking a proper long-term perspective aligned with your goals and risk tolerance.
“All financial success comes from acting on a plan. A lot of financial failure comes from reacting to the market.” – Nick Murray
If you are nearing retirement have the gains in the market accelerated where you are in terms of your goals? If so it could be worthwhile to reduce your exposure to stocks.
It’s also worth considering if your asset allocation still appropriate. Has your situation changed? Did you get married, divorced or have other life changes occurred that might dictate changes in your investment strategy? These are among the questions that we always ask clients, but especially with the markets at levels like this.
To help break this down further, what a new record really means to you, is that no matter how much money you might have “lost” during that market downturn, if you left it invested, you would have it all back. That’s right – every last penny and more.
That’s because the new stock market record means that the current index price is not only higher than it was when you originally lost all of your money, but it has reached an even higher value than it was before this point.
In other words, a new stock market high means that the current stock market has recovered any loss it ever had. And it will probably do it again next time, too…
SHOULD YOU SELL IN ANTICIPATION OF DECLINE?
Aside from rebalancing your portfolio, the answer is no. None of us can accurately predict what the stock market will do with any consistency, so your focus should be on the long-term versus what might happen over the next year or two.
Even more important than not selling in anticipation of a market decline, it’s important not to sell during a market decline out of panic. During the financial crisis the papers were filled with stories of many people nearing retirement who panicked and sold out of their stock holdings near the bottom of the market.
They not only experienced horrible losses, and in many cases these investors missed out on much or all of the market’s stunning rebound over the past 8+ years. In some cases they even saw their retirement plans ruined by fear.
The better approach is to be prepared. Planning beats panicking 100% of the time.
Instead, be sure you have enough cash or liquid, low-risk holdings to meet your withdrawal needs, including required minimum distributions. It’s important to plan for how you will handle things once the market drops.
THE ALIGN FINANCIAL APPROACH
We have a disciplined and sophisticated approach – but it’s easy to understand. We have a defined process that holds us and our investment managers accountable. We rebalance our clients accounts every single year, like clockwork. We hire proven and trusted investment managers that are responsible managers of capital. Most importantly, we help you understand your money and your investments and how they really connect to your life and your priorities.
The bottom line is: the key to successful investing is more about human behavior than money. Many people think that there might be a secret to timing the market tops and bottoms, and that’s how real wealth and financial security are created.
But in reality, it’s simpler than that. The people who save more money, simply have more money. People who are clear about their priorities, usually have more money or security or both. A plan is the key. That’s why we spend so much time understanding our clients lives and their money before we make investment decisions.
We make sure the money we’re investing has a meaningful job to do and role to play in your life. This allows you to sit patiently during difficult times when the news would have you think that there’s a “better way,” when in fact, real wealth is created over many strategic, but simple decisions over long periods of time. It’s simple, but not easy.
As always, if your plans for the future and your money hasn’t changed, we don’t change the investment strategy. And if your plans HAVE changed, be sure to check in to catch us up on the new developments in your financial story.
Feel free to contact us to have a conversation about your money and the markets, and why we don’t get too worked up over market highs or even market lows.