By Allen Ostrofe
Vivian called recently from Novato, California, acknowledging almost apologetically that the recent volatility of the U.S. markets appeared to be exactly what so many have projected for so many months. She explained that she understood that corrections come regularly and she needed to be prepared.
Vivian commented that she felt she was mentally prepared, but not as prepared emotionally. She acknowledged that many market indices had double-digit returns last year, but that was quickly forgotten when she, personally, had to "give back" a single digit return this year. Vivian felt all the gains she had last year should be "hers." She commented that the percentage which was taken away from her early this year, no matter how small, felt like something was personally stolen from her.
This sounds like a classic Behavioral Economics case. Vivian asked that we provide more background, so she might feel more grounded and secure. We agreed. We shared with Vivian that the last two years of U.S. markets' "volatility," in spite of media bravado, have been historically low. As a matter of fact, the "VIX," a measure of U.S. markets' volatility, was at a 15-year low last year.
Percents or Points?
Last year, the U.S. markets experienced the lowest volatility in 15 years. Although many of U.S. markets’ historical daily performances have averaged a one-percent-per-day price swing, this rarely happened last year.
A one percent daily price swing of the Dow Jones Industrial Index at an example value of 25,000 would be 250 points. Does that sound like a lot? That is only one percent. What if someone told you the value of your house went down one percent on a certain day? How worried would you become?
Still, it is important that investors only focus on percentage changes, not point changes. What sounds more dramatic to you, 250 points or one percent? What about 1,000 points or four percent? Points only sell headlines; percentages drive your portfolio. It is important to keep a historical perspective when evaluating recent market conditions. The average intra-year U.S. stock markets corrections over the last 35 years has been over 14 percent. The U.S. markets ended higher on 27 of those 35 years.
Markets' pullbacks are normal and common. Some analysts suggest that we experience a "correction" (technically a downturn of ten percent) on average, every two years. Our last correction was in August 2015. No one questions that one was due. Many question how to best prepare for them.
It is impossible to forecast precisely the performance of the stock market over the short term. However, stocks have historically exhibited higher volatility in the short term and higher returns over the long term relative to other asset classes such as bonds and Treasuries.
It is prudent to take into consideration one's unique circumstances, including one's investment time horizon and liquidity needs. We prepare for the risk of volatility in one asset class through proper diversification. That is why so many advisors and their investors have been systematically "housecleaning" more aggressive positions in their investments over the last year, and replacing them with more conservative positions in anticipation of what we see as "regular and periodic" corrections.
Henry Kaufman, a storied portfolio manager from the Midwest once said,
"Growing a portfolio is like farming fertile land; once in a while you have to pull the weeds!”
Corrections, like storms, always come. They always will. You can hide from them and grow nothing, or prepare for them and harvest what you have saved. The key to realizing higher returns is to avoid panicking or acting impulsively during market corrections.
As John Bogle, the founder of Vanguard Funds said in regards to investing:
"Time is your friend. Impulse is your enemy."
We hope Vivian is now sleeping better, and that some of our perspectives and opinions provide some light on recent events.
A special thank you to Seth Leishman for his thoughts shared in this article.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Allen Ostrofe, MBA, CFP, is president of Ostrofe Financial Consultants, Inc., with clients in 31 states and is a registered Representative with, and Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Ostrofe Financial Consultants, Inc., a Registered Investment Advisor and separate entity from LPL Financial. For questions or suggestions, visit ostrofefinancial.com. Branch address: 565 Brunswick Road, Ste. 15, Grass Valley.