The Legacy Perspective – April 2019
By Steve Wachs, CFP®
“Life is like a roller coaster. Sometimes you close your eyes and hold on in sheer terror, other times you just have to raise your hands up in the air and enjoy the ride.”
What does the Incredible Hulk, Millennium Force, Space Mountain, The Beast, and Lightning Rod all have in common with the stock market? They are all world class roller coasters and the stock market has certainly put investors on a down and up ride the last 6 months. The S&P 500 Index almost entered bear market territory with a 20% decline from September 20th through December 24th. Since that time, it has rebounded back with a 24% increase. Let’s explore what we learned from the past 6 months to be better long-term investors.
In our office, Kimber loves roller coasters. The high speeds and the big drops all add to the thrill. On the other hand, Jen hates them. She sees nothing intelligent about the risk of vomiting on herself or the people behind her. Kimber sees the thrill, Jen sees danger. Investors have different risk profiles. Some see financial risk as an opportunity or thrill, others see it as uncertainty or danger. That is why we use FinaMetrica, a risk assessment tool that provides a risk score for each client and allows us to have a discussion about risk before we provide any investment recommendations.
Roller coasters have different speeds, different drops, some go upside down, some backwards, some are wooden, and some are steel. But what do they all have in common? They all end up where they started. Each passenger gets on board, puts their seat belt on, goes for the ride, raises their hands, screams, and stops right where they began. The only way that doesn’t happen is if they foolishly took their seat belt off and jumped out of their seat during the ride. That is why understanding your ability to tolerate the short-term ups and downs of the financial markets is crucial. One of the questions on FinaMetrica is “how much could the total value of all your investments go down before you would begin to feel uncomfortable?’ When we discuss this question, we ask what “uncomfortable” means each person. Is it “I don’t like how my values dropped this month” or is it “Get me out of the market, stop the bleeding!” With December 2018 being the worst December since 1929 for the S&P 500 Index, it may have been tempting in January to have that “get me out” feeling. However, a key phrase we have used for a number of years is that you can’t let emotions dictate actions. Most clients’ portfolio values are back to where they were on October 1st. That would not be the case is if you took off your seat belt and jumped.
Some of you (most likely engineers) may be saying roller coasters don’t always end up where they began. Some of them break down and are stopped in mid-ride. Actually, they ultimately do get back to where they started; it just may take longer than expected. That can be the case when the stock markets goes through a major decline like it did twice during the past decade. In investment terms, that is called “drawdown risk” which is how long it takes for values to recover from their decline, back to the original peak. We manage this type of risk by designing portfolios that use different types of investments that don’t go up and down at the same rate or time. This diversification reduces portfolio decline, which in turn reduces the amount of time for recovery. These dramatic, extended downturns can be painful to experience. No one really knows when the next downturn will occur. However, we do know how to manage portfolios to get clients these cycles and provide the best opportunity to accomplish their financial life goals.
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