Cooling Off

Adam M. Grossman

TODAY’S STOCK MARKET reminds me of Charles Dickens’s famous line: “It was the best of times, it was the worst of times….”

It’s the best of times, of course, because the market continues to hit new highs. From a low of 2,237 in March 2020, the S&P 500 has doubled. Over the 10 years through July, the S&P has delivered an average annual return of 15.4%, including dividends, far above the historical average of 10%. Since the downturn in 2009, the market has logged just one negative year: In 2018, there was a modest, all-but-forgotten decline of 4.4%.

So why would anyone say that it’s also the worst of times? The worry is that things are too good. Investors have enjoyed seeing the numbers on their financial statements get bigger, but it also feels like climbing a ladder: With every step higher, there is farther—potentially—to fall. And it isn’t just the stock market. With interest rates near all-time lows, the potential for losses in the bond market has also grown.

As investors, we’re all taught to think long term. Everyone understands that the market can be unpredictable and volatile from year to year, so we’re supposed to stay focused on the horizon, not the day to day. But there’s a difference between what we know we should do and what we’re actually capable of doing. While the overall market results cited above have been very positive, it certainly hasn’t been a straight line. The pandemic has left millions unemployed and has turned some industries upside down. The financial markets are also displaying excesses—from cryptocurrencies to meme stocks—that make people nervous.

This skittishness isn’t just affecting those currently invested. You also see it among those sitting on the sidelines, too nervous to put money into a market that appears “priced for perfection.” In an environment like this, how can we keep our investment cool? Below are six ideas:

1. Remove emotion. What does this mean in practice? Whether you work with an advisor or not, I would draw up a formal investment policy statement. It need not be complicated—a single page will do.

In this document, you can spell out your strategy, including asset allocation targets and rebalancing rules. Then try hard to adhere to it. This can be valuable in an environment like today’s, but it can be even more helpful when the market goes haywire.

Consider what stocks did early last year. Before the Federal Reserve stepped in, the market plunged more than 30%—its quickest decline ever. The drop was terrifying, and no one knew when it would end. But investors who had asset allocation targets and rebalanced according to their plan benefitted greatly during the ensuing rebound.

2. Forget forecasting. The stock market is cruel. It can make the smartest person feel clumsy. Again, think back to last year. As Zoom took over people’s work lives, many predicted doom for commercial real estate. Others, meanwhile, worried about the election. And as the pandemic raged, many worried that we were headed for a prolonged economic downturn. One prominent hedge fund manager declared, “Hell is coming.”

Things, of course, turned out much better than anyone expected. As a result, the investor who fared best was the one who didn’t tinker too much. It’s counterintuitive, but—unlike in other areas of our lives—there’s only a loose connection between effort and results when it comes to investing.

3. Take it slow. If you have cash you’d like to invest but are hesitant to jump into the market, that’s understandable. Dollar-cost averaging is a common solution to this problem. Can you do better? Maybe. There are lots of variations on traditional dollar-cost averaging.

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For instance, there’s value averaging. Indeed, I often accelerate stock market purchases when prices drop. But ultimately, there’s no way to know in advance which buying strategy will deliver the best result. The most important thing, in my view, is just to get started at a pace that you’ll be able to stick with.

4. Take the long view. The late Jack Bogle, founder of Vanguard Group, urged investors to think in terms of decades. That’s because the market is entirely unpredictable in the short term but at least a little bit predictable in the medium and long term. If the market is high today, for example, it might be even higher next year. But it stands to reason that prospective returns over the next decade will be lower following a dozen years in which results were so far above average.

What does this mean for you? If you’re in retirement or retiring soon, you’ll want to build a financial buffer into your plan. I wouldn’t count on 10% returns—the historical annual average—over the coming decade. On the other hand, if you’re earlier in your career, it would defy math to conclude that an expensive market today necessarily means that returns will be below average for multiple decades into the future. Yes, you want to consider that possibility in your financial plan. But it’s just one potential outcome. If you’re 30, 40 or even 50 years old today, I wouldn’t take an overly defensive posture just because the market currently seems high.

5. Consider history. Investment commentators love debating whether the market is headed higher or lower. But these debates usually aren’t productive. I’m not predicting that the market will go down or that it’ll go up—in the near term. Instead, what I’m predicting is that over the long term it will go higher. That’s where I find history instructive.

If you went back to 1929, I’m sure there was a lot of handwringing after the market had doubled over the prior two years. Similarly, there was plenty of investor angst in 2000 and 2008. And those worries were vindicated, but only in the short run. In all of these cases, the market eventually bounced back and went much higher. I see it the same way today. Maybe the market is high and maybe the next decade will be far less profitable. But that isn’t guaranteed—and it tells you nothing about the decades after that.

6. Have faith. In recent years, I’ve heard growing murmurs that America’s economy is starting to crumble—and that we’re headed for a long period of malaise like Japan or even the Roman Empire. Are those things possible? I suppose.

But I’ve also heard powerful arguments to the contrary. Larry Siegel’s 2019 book Fewer, Richer, Greener argues that we’re entering a period of unprecedented prosperity. I’m not sure which version of the future we’ll see.

But again, consider history. As Warren Buffett noted in 2008, “In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president.”

We can now add another pandemic to that list, and no doubt there will be other unnerving events in the decades ahead. Still, I believe history’s lesson is clear: Our economy—and our markets—will continue to prosper over the long term.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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Philip Stein
Philip Stein
1 year ago

With regard to taking the long view:

I suspect that most HumbleDollar readers would agree that compound growth is a better path to wealth than stock picking. I also suspect that many people who began life in humble circumstances and reached millionaire status during their lifetime probably achieved this happy state via the compounding of their investments over the years rather than any inherent ability to sidestep bear markets or pick the best investments.

With that in mind, I often wonder why some younger people find it difficult to adopt the “long view.” Speaking for myself, I believe I was better able to acquire a long-term perspective after I learned about the power of compound growth from reading some of Warren Buffet’s missives. Of course, Buffet is a big advocate of patient, long-term investing (“my favorite holding time is forever”).

I would add a seventh idea to Adam’s list. Take a breather from fixating on the stock market and learn about compound growth and how it unfolds over decades.

1 year ago

It would seem “This time it’s different” applies to both the upside and downside. As Benjamin Graham said, “In the short run, the market is a voting machine but in the long run it is a weighing machine.” It always amazes me that observations from many, many years ago still hold true today.

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