Headwinds

The stock market has hit a rough patch recently, falling 5.75% since the Federal Reserve cut interest rates on July 30. Headwinds have been stout as market participants react to the trade war, protesters in Hong Kong, Brexit, Trump’s tweets, and calculated language from Chairman Powell.

The recent selloff follows the May decline when stocks fell 7%. For the past 50 years, the average decline from a market top has been 10.7%.[1]

Are this year’s headwinds worse than in previous years? You might say yes because of recency bias. However, it’s in-line with previous market pullbacks.

Here are a few facts.

• The Dow Jones is up 9.23% for the year and 171% for the past ten.
• International markets are up 4.32% for the year and 19% for the past ten.
• Long-term bonds are up 20.8% for the year and 57% for the past ten.
• A globally diversified portfolio of stocks and bonds (60% stocks, 40% bonds) is up 10% for the year and 104% for the past ten.
• The 30-Year U.S. Treasury bond is currently yielding 2.03%, a historic low. In 1990, it paid 8%.
• The current U.S. inflation rate is 1.81%. In 1980 it was 14.5%.

Let’s review how a 60% stock, 40% balanced index performed during past routs if you held on until the end of last year.[2]

• Stocks fell 48% from 1973 to 1974. If you purchased the index before the drop, your average annual return was 10.4%.
• Stocks fell 19% in 1990 during the Gulf War. If you purchased the index before the drop, your average annual return was 8%.
• Stocks fell 43% during the Tech Wreck. If you bought the index in 2000, before the drop, your average annual return was 6.8%.
• Stocks fell 53% during the Great Recession. If you bought the index in 2007, before the drop, your average annual return was 4.7%.

Markets turn quickly, so it’s best to own a globally diversified portfolio of low-cost funds.

I understand that emotions trump facts when stocks fall 500 points or more. It’s human nature to want to sell your investments and wait for trouble to pass. When fear is high, investors want to trade stocks for bonds until the coast is clear. If you invest in a portfolio of U.S. Treasuries, your current yield would be approximately 1.8%, or about the rate of inflation, so after subtracting inflation, your net return would be zero. It will be less than zero after paying taxes on the income you received.

Are you concerned about the loss of your principal? If so, here are a few steps you can employ today.

• Reduce your stock exposure. If your stock allocation is 60%, lower it to 40%. Lowering it will reduce your risk by 25%.
• Increase your cash position to cover three years’ worth of household expenses. If your annual expenses are $100,000, keep $300,000 in cash or short-term investments. A three-year cash cushion will allow you to ride out most market corrections. For example, if you had a high cash reserve from October 2007 to October 2010, it would’ve allowed your stock investments time to recover. In other words, you didn’t need to sell your stocks at the bottom of the Great Recession.
• Rebalance your accounts to keep your allocation and risk level in check. Since stocks and bonds fluctuate, your asset allocation will change if you do nothing. If you started with a 50% stock, 50% bond portfolio ten years ago, it would have a current allocation of 72% stocks, 28% bonds. By doing nothing, your risk level increased by 37%. An annual rebalance will keep your portfolio allocation at 50/50.[3]
• Buy the dip. It takes courage and wisdom to buy stocks after they’ve fallen dramatically. Investors who purchased stocks in March 2009, after falling 53%, were rewarded with a gain of 322%! An investment of $100,000 is now worth $422,200.[4] Using the past 100 years as a guide, then buying stocks when they’re down is an intelligent strategy.

Investing is a courageous act, especially when your investments are tumbling. Short-term trading, mixed with short-term thinking, will derail your long-term plans. Rather than acting on impulse, focus on your financial plan. A well-designed plan accounts for multiple scenarios, including broad market declines. If you’re not sure how your investments will impact your financial future, give me a call and let’s figure it out.

I believe the market is going to fluctuate. ~ J.P. Morgan

August 15, 2019

Bill Parrott, CFP®, CKA® is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ than those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.