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What are you doing “differently”?

By: Jason Whitby

By: Jason Whitby, MBA, CFA®, CFP®, AIF®

We have had a lot of inquiries recently, often from the media, about what changes we are making for our clients in today’s markets. The question always seems to imply that we should be doing something differently when the stock markets do not “behave”. I would like to take this opportunity to answer with the proverbial, “Why?” as in “Why would we be doing something differently?” Here are four possible guided reasons as to why some investors, professionals included, might start doing things differently when the markets head down.

Reason #1: Perhaps, we changed our mind and no longer believe the average person can make money in the stock market.

On the contrary, at Investor Solutions we still believe that the average person can make a fair return by just accepting the average stock market returns. Since January 1973, the S&P500 produced a return of 10.6%. The average person only needed to buy the entire market and hold on. We do not believe this has changed. We continue to believe that investors with too much cash and fixed income will barely tread water. Few people sit and really consider how much risk inflation is to their future. After all, think how much you paid for your first house and how much you paid for your last car. Too long of a time period you say? How about this; gasoline five years ago was around $2/gallon. Today it’s closer to $4/gallon. Inflation is a real threat to all of us planning to inhabit the earth a little longer.

We still believe in the capital markets and capitalism. That a few corrupt CEOs and the Wall Street Gurus do not, over any length of time, control the stock markets. The sky is not falling and the world as we know it will go on. You might know the phrase, “What has been is what will be, and what has been done is what will be done. There is nothing new under the sun”.

Reason #2: Possibly, we were not expecting the stock market to go down.

That may come across as flippant but it certainly is a possibility. After all, it was only a few years ago that many people believed you couldn’t lose money in residential real-estate. However, we still believe in risk and reward so the stock markets will go up and will inevitably go down. All of us understand risk and reward. We know that the reward of a beautiful tan today is at the risk of future wrinkles or even skin cancer. But many of us do not appropriately relate risk and reward in investing. First, you must believe that you will be fairly compensated by the markets for the risk you take. You also must believe that there is no reason to take uncompensated risk. Too often people mistakenly believe that the more risk they have, the more reward they will receive. But that isn’t true. As in life, only certain risks in investing are compensated. The remaining risks are not rewarded, so why take the risk? This concept of compensated and uncompensated risk is not very confusing if we apply it to our daily driving routine. You understand the reward of the automobile; quick, convenient and comfortable. But how often do we sit and contemplate the risk? We are traveling in a high speed, metal box and know people can die at any moment without any notice. So do you avoid the risk? No, you have airbags, good brakes, follow the laws, use seat belts, pay attention and so forth. You know that driving with your seat belt off, speeding with your head out the window singing to the radio will not get you to your destination with little additional enjoyment. However the risks are greatly increased. So you do what makes sense and limit the non-compensated risks by being a good driver and having a safe car. The same principal applies to investing, identify the compensated risks and limit your exposure to all of the other risk factors.

We believe that stock markets will have periods of positive returns and periods of negative returns. On average, the expected return is well worth the volatility if you properly limit exposure to uncompensated risks.

Reason #3 Maybe we make changes when the markets head south in order to look like an expert.

I suspect the need to look important and be needed is too often the reason professionals start making changes in a down mark. And it’s hard to blame them. Human nature and experience has led the public to believe that something needs to change if the results do not meet their immediate expectations. If the division is doing poorly, get a new manager. If the product isn’t selling, change the package. If the investments are going down, get new investments. So the public often demands a “fix” for their accounts. At Investor Solutions, we react to changes in the client’s needs and objectives, not to the whims of the markets. We believe that if we did our job properly prior to any market correction, then there shouldn’t be any need to change. We believe in doing the right thing for the client, which very often is simply “Stay the Course”. However, staying the course is not the same as “buy and hold”. Staying the course means sticking to the plan, and the plan doesn’t include knee jerk reactions to sell. Nor does the plan include a false impression that we are making the needed changes to correct the direction of our account. This type of activity creates unneeded taxes, transaction fees and is usually counter productive to your future returns

Reason #4: We believe we can time the market and predict the future.

“Is it a good time to get in? Is it a good time to get out? What do you think?” Honestly, speculating is fun and has a long tradition in investing as it does in politics and sports. Speculation is a great past time and very entertaining. But when you put your dollars behind your speculations, you are gambling, not investing. So if you feel that you can pick the top and the bottom, please keep the following numbers in mind.

Over the last 15 years, the S&P500 has returned roughly 18%. If you would have missed the best 40 days over that time period, you would have only returned 8%. If you would have missed the worst 40 days, you would have returned 32%. Now 40 days out of 15 years is roughly 1%, and 1% is pretty close to a zero percent change of timing it correctly.

We believe in investing, not gambling. We believe that no one can time the market over the long term. And if there was someone who could successfully time the market, why would they share the wealth with you?

Conclusion

So what does Investor Solutions do when the markets are down? The process is the same when the markets are going up as when the markets are going down. We review each client’s investment policy statement and asset allocation targets. This tells us if there is anything to be done.

So what can investors do when the markets are down? Instead of looking to change your investments, it might be more beneficial to focus on the things that you can control. You might need to save more, spend less, or work longer.

For most investors, more unhappiness will be derived from market worries than from market results meaning the stress and pain experienced from market volatility is far great than in needs to be. Stick to the investment plan, rebalance, harvest losses when appropriate, and try not to over analyze. Sometimes the best decision is the decision to do nothing different