By Joseph Goldy, AAMS®
One question I often hear is: With the market being so unpredictable, how can we properly plan for the long-term? A global pandemic, upcoming elections, trade tariffs, record unemployment, GDP in freefall, there is no shortage of reasons why the market could be declining this year. Yet, the stock market is not falling, it continues to push higher, led by the information technology and consumer discretionary sectors. Over the last year, out of the 11 sectors of the economy, only consumer staples and energy lagged the S&P 500.
While it is true, the market is unpredictable; it is helpful to understand that there is a difference between speculating and investing. Speculating in the market is more akin to gambling and has no place in a prudent long-term investment strategy. While some people feel investing in the stock market is like going to a casino, the opposite is true.
Graphic credit: Invesco
The graphic highlights that the odds are in favor of the casinos, whereas investing, particularly over more extended periods, has a high probability of ending in the investor's favor. For someone with a 10-year time horizon, there is more than a 96% chance that they will experience a positive return. Contrast this with popular casino games, and you can see that even the games with the best odds offer a less than 50% chance of making money.
Understanding that investing in a well-diversified portfolio has a positive expectation, the longer you stay invested, is an important concept to comprehend. If you genuinely believe this, it eliminates many of the short-sighted mistakes investors tend to make when unforeseen market events occur.
Clients who have a well thought out plan and follow a strategy tend to stay invested despite unexpected volatility or uncertainty around upcoming events.
Another equally important idea is that you do not have to predict where the market will go to be a successful investor. During my years working in the discount brokerage area of financial services, I encountered many clients who were trying to chase the hot sector or the current hot investing idea. Dot-com stocks, gold, oil, Chinese stocks, cryptocurrency, and marijuana stocks all come to mind as recent examples of investments that saw a quick rise in price, only to return to more normalized levels. These spikes were driven either by prices getting ahead of fundamentals or by pure speculation. The upshot is the temptation to participate in quickly rising investments, often becoming too great for many investors to pass up. Unfortunately, if your timing is not perfect, speculating can end in considerable losses.
Chasing performance is not a new phenomenon. Dating back to the 1600s, tulip mania is often thought of as one of the first investing bubbles, with tulip bulbs' prices skyrocketing on speculation, only to collapse a short time later. Trying to time the market or buy into the next "hot idea" is a recipe for underperformance. Like when you are stuck in traffic and see other lanes moving, you feel the urge to change lanes quickly. Invariably though, the lane you just switched to then comes to a grinding halt, and you get to watch as the other lanes begin to move. A similar outcome can occur when investors are trying to chase the next hot stock or fund.
It is critical to understand that it is not necessary to time the market to be a successful investor. Merely having a firm understanding of your specific portfolio's long-term return expectation and judiciously planning around that provides the advantage over speculating. Along with this comes significantly less stress than trying to time the market or the feeling of regret of missing out on returns.
As damaging as speculating is to an investor's returns, perhaps equally as harmful is someone holding off on investing in the market due to uncertainty around current events. Waiting for the "all clear" sign with the stock market is waiting for something that may never come. This lack of conviction can cause too much cash to sit on the sidelines and not earn a return high enough to reach your goals or, at the least, keep pace with inflation to maintain purchasing power over time.
Graphic credit: Invesco
As the graphic above shows, unpredictability is the norm, not the exception. In the last 20 years alone, the tech bubble collapse, the 9/11 terrorist attacks, the 2008/09 financial crisis, and now a global pandemic have all tested investors’ nerves. Along the way, it was not a smooth ride, but the S&P 500 index has gone from around 800 to its current 3400, rewarding investors who could stick with their long-term plan.
When unexpected events such as these occur, the Highland investment committee will look for tactical opportunities to rebalance, harvest tax losses, or add to undervalued, fundamentally strong assets. Our clients benefit from our consistent analytical process and unbiased assessment of the markets during these times. Speculating on the direction of markets is driven by fear and greed. Likewise, trying to time the perfect entry or exit points when investing is also not necessary to be successful over more extended periods. By following your strategy and staying focused on your long-term plan, you will be less likely to succumb to these two powerful emotions and begin using them to your advantage.
Author’s Bio
Joseph Goldy, CFP®, is a wealth advisor and CERTIFIED FINANCIAL PLANNER™ at Highland Financial Advisors, LLC, a fee-only fiduciary wealth advisory firm based in Wayne, New Jersey.
Joe specializes in working with newly independent women because of divorce or losing a spouse. He understands firsthand the value of having a clear financial picture pre- and post-divorce and a plan to restate goals as a single person. When he is not helping clients, Joe enjoys spending time with his two sons outdoors and volunteering to help raise money for Type 1 diabetes organizations.