Unpleasant Investing -- Weathering the Storm

 
Posted1/16/2019 1:00 AM
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  • John P. Daly

    John P. Daly

2018 was a reminder for many investors that investing can be uncomfortable and unpleasant. Most people invest in the stock market to grow their wealth. Last year, the opposite happened, portfolios lost value (especially in Q4) and stock investors were not alone. Even some bond investors had negative returns for 2018. This has caused fear to set in for some investors who are concerned about their future returns and preserving their wealth. So, what should investors do?

First, you need to understand what is going on with the market and realize as uncomfortable as it might be, it is also very normal. Volatility is, by definition, a rapid and unpredictable change. Volatility as it relates to investments measures the risk of an investment. In 2018, stocks indexes were down anywhere between 10 percent to 20 percent from recent highs. Yes, these pullbacks are unpleasant, but they are not abnormal.

To put the recent volatility in perspective, since 1980 the average intra-year decline of the S&P 500 was almost 14 percent. Even with those intra-year declines, the S&P 500 ended up having a positive return in 75 percent of those years. So, having a double-digit decline in the stock market is not anything new; it's actually very common.

Staying the course during extended periods of volatility is hard for many investors to do. It comes with experience, discipline and good guidance.

One thing investors should understand is something called the risk premium. It's the amount of return investors expect over a risk-free asset. For example, the excess return you expect to receive investing in stocks vs. U.S. Treasury bonds. That excess return comes with increased risk (volatility). The stock market never goes up 100 percent of the time and when it does have pullbacks, many of those pullbacks have been sizable. However, the risk associated with the stock market is also why it has had significant excess returns over bonds historically. As an investor, if you are trying to capture that excess return, you need to accept the additional risk.

However, not everyone has the same risk tolerance. That's why it's important to make sure your portfolio is properly allocated to tolerate these bouts of volatility and still achieve your long-term goals. For example, if your goals have shifted to income and capital preservation, you should probably decrease the stock exposure in your portfolio to reflect that. If wealth accumulation is still a main goal, staying the course and rebalancing to take advantage of lower equity prices have rewarded investors historically and can lead to long-term gains.

Unfortunately, it's impossible to tell when volatility slows down or when the markets regain their upward course. That part of investing is out of your control. Instead of making hasty decisions with your portfolio, you should instead focus on the areas you can control. Review your allocation to make sure it matches your current goals and risk tolerance. The last recession we had was 10 years ago; if you haven't revisited your financial goals since then, now would be good time.

Diversify broadly to minimize risk. Diversification is one of the only "free lunches" with investing. Not only can you minimize risk by not having all your eggs in one basket, but you can also increase potential returns. Also, you should pay attention to turnover and taxes. High turnover and taxes can significantly eat into your annual returns. Make sure your portfolio does not have unnecessary turnover and is managed to minimize any tax liability.

Following these tips might not erase all the pain during these extended bouts of market volatility but it should make your experience more comfortable.

• John P. Daly is a Certified Financial Planner and president of Daly Investment Management LLC, www.dalyinvestment.com, a fee-only Registered Investment Advisor specializing in financial planning and wealth management.

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