This Time is Different – or Not?
“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
– Peter Lynch
As stock market volatility increases, investor emotions can start to get in the way of logic and they may feel the need to ” do something” to protect their investments. As Peter Lynch, the iconic money manager of the Fidelity Magellan fund, states in the quote above, far more money is lost in response to anticipated corrections than in corrections themselves for a couple of reasons. The first is that you have to be right twice – once when you try to predict the bottom or the peak and then again when deciding the best time to go back in to the market. While an investor is sitting on the sidelines, he or she loses the opportunity to participate in the recovery because of their fear related to going back into the market after suffering a loss. Remember that losses are inevitable if you are going to be an investor. The market does NOT always go up; “this time ” is not different.
So what can you, the investor, do?
You may not be able to completely avoid losses; but, you can minimize your losses by determining how much downside risk you want to take on and then allocating your assets accordingly between stocks, bonds, real estate, cash etc. There is, however, a caveat. If you choose a lower risk portfolio, you are not going to have the same upside potential that being fully invested in the stock market provides. Investors have short memories when it comes to risk. They want all of the upside potential with maximum downside protection. Those concepts are correlated with what is known as the ” risk/reward” trade off. In order to control losses on the downside you have to reduce your exposure to stocks, and thus your upside potential as well. In other words, you can’t have it both ways.
Other strategies that many people don’t practice or don’t understand are dollar cost averaging and rebalancing. Dollar cost averaging involves investing a set amount of money each month no matter what the market is doing. If the market prices go up, you buy less shares; accordingly, if market prices go down you buy more shares. This practice requires disciplined, consistent investing despite what is going on in the market or economy. This takes self control and keeping your eye focused steadily on your goals rather than listening to the talking heads shouting doom and gloom.
Rebalancing is an investment practice that helps to keep your risk tolerance aligned with your goals over time. It involves periodically moving money from one piece of your portfolio to another, based on performance, in order to keep the overall allocation in line with your appetite for risk and long term objectives. For example, let’s say you have 40% in US stocks and 20% in international. The US portion goes up to 45% based on that class performing well and your international funds drop to 15% based on less competitive performance. To rebalance, you would sell off 5% of the US portfolio and buy 5% in the international portfolio, at lower prices, to realign the total accounts back to their original 40/20 allocation. Sounds counter-intuitive, I know, but this demonstrates the “buy low, sell high” concept that can be so crucial to your long term account performance. Asset classes will continue to go up and down over time so rather than trying to guess the peak and trough of each asset class, this allows you to own them all and rebalance to maintain alignment between your portfolio and your goals when necessary. This can be done annually or quarterly but that decision should be determined by you and your advisor based on your tax situation.
The main takeaway here is find an allocations that match your sleep at night factor and are in line with achieving your most important life goals and then to stick with your plan!!
Please contact me with any questions!!
Kathy Fish, CFP®, CLU, ChFC
The opinions expressed in this commentary are those of the author and may not necessarily reflect those held by Kestra Investment Services, LLC or Kestra Advisory Services, LLC. This is for general information only and is not intended to provide specific investment advice or recommendations for any individual. It is suggested that you consult your financial professional, attorney, or tax advisor with regard to your individual situation. Comments concerning the past performance are not intended to be forward looking and should not be viewed as an indication of future results.
Rebalancing assets can have tax consequences. If you sell assets in a taxable account you may have to pay tax on any gain resulting from the sale. Please consult your tax advisor.
Using asset allocation as part of your investment strategy neither assures nor guarantees better performance and cannot protect against loss of principal due to changing market conditions.
All investments involve varying levels and types of risks. These risks can be associated with the specific investment, or with the marketplace as a whole. Loss of principal is possible.
Posted on September 29th, 2016 in finance.