Almost on a daily basis, some financial “expert” offers his (or her) Chicken Little version of why the stock market is set to crash and what investors should do to prepare. I once saw a chart titled “Reasons to Sell” beginning in March 2009 (the trough of the financial market collapse) that highlighted events such as Chrysler/GM File for Bankruptcy, S&P Downgrades US Debt, US Government Shutdown, and many more calamitous headlines that foretold of impending stock market doom.While stocks may have pulled back somewhat in those situations, in no instance to date has the stock market not recovered. In fact, when the US debt was downgraded on August 5, 2011, the S&P 500 closed at 1,199.38, and it closed yesterday (March 19, 2019) at 2,832.57, an increase of over 236%. These harrowing prognostications can occasionally be enough to make even the most jaded, hardened investors take notice, but for the average investor, they understandably raise fears and uncertainties. So what’s the average investor to do to prepare? Most often, the answer is nothing.
The biggest risk investors face when trying to time the market is not necessarily when to get out of the market, but rather when to get back in. Keeping cash on the sidelines during market recoveries has a deleterious effect on investment performance and portfolio valuations. A study by Putnam Investments showed that by not being fully invested on the 10 best days of the market for 2014-2018, a $10,000 portfolio invested in the S&P 500 would have earned only about half as much as a portfolio in the market during the entire time period. The average annual return for the S&P 500 over that time was 7.77%. Missing the 10 best days of performance reduced the average annual return to 2.96% and reduced the final portfolio by over $15,000.
Looked at another way, Albert Bridge Capital wrote about "The Futility of Market Timing" and accumulated wealth. The analysis looked at a hypothetical investor with “perfect foresight” who was able to pick the perfect price (lowest daily close) to invest $1,000 per year for the 30 years starting in 1989. Today that portfolio would be worth nearly $156,000, an average annual return of 9.7%. On the flip side of that, now imagine the “perfect idiot” who picked the worst day to invest. His (or her) portfolio would have accumulated $122,000 over the same time period, having an average annual return of 8.4%, really not that much less. This study reinforced a Pension Partners analysis that concluded what matters most for long term portfolio accumulation is not how much an investor’s investments earn, but rather how much the investor regularly contributes to the portfolio.
These studies are good news for the disciplined investor. They basically highlight that long-term financial success is based more on what the investor can control, namely how much he (or she) saves, rather than on factors out of his hands, such as market performance.
Does that mean investors should stick their heads in the sand and ignore market risk? Absolutely not! Rather, investors living off of their portfolio should ensure they have enough guaranteed income or portfolio liquidity to meet their cash flow needs for an extended period of time without having to sell stock (or stock mutual funds) when the market has corrected. For our retired clients, we generally plan to have enough cash (or cash-like investments) or maturing fixed income to meet 18 to 24 months of living expenses. Investors with a longer investment time horizon (and are likely still employed) should establish an asset allocation target that helps them reach their financial goals in a manner that allows them to sleep at night. When the portfolio allocation becomes out of balance due to market performance, the portfolio should be adjusted to targeted allocations. Adjustments can take place either through large scale portfolio changes, or through tweaking how regular contributions to the portfolio are invested.Is it nerve-wracking to hear stock market pundits discuss the next market crash? Of course it is, and since no one can predict the future, the best thing you (and your financial planner) can do is be prepared. Make sure your plan provides the liquidity and cash flow you need to meet your short and long-term goals the next time “the sky is falling”.
Written by Teri Christensen, MBA, CFP®