I hope you are enjoying the dog days of summer! Global stock markets delivered robust gains in the second quarter of 2017 as stronger earnings growth, upswings in global economic data and diminished political uncertainty in Europe all buoyed markets around the world. The S&P 500 rose 3.1%[i] while domestic economic data continued to plug along at a healthy, if not exciting, pace. It’s wonderful to have positive economic data to reflect upon. However, whether the headlines this week are about the new market high or a looming market correction, the most important takeaway is to stick to your long-term investment plan and concentrate on the big picture.
This week the Dow Jones Industrial, arguably the most frequently referenced stock market index in the world, reached an all-time high of 22,000. Since the bottom of the recession in March 2009, the Dow has more than tripled in value, creating one of the strongest bull markets we’ve ever seen. However, our current bull market reached a milestone 8 year run this March[ii]. While some are finally comforted to get back into the market, others are warning that the sky is falling and to lock in gains while you can. While a typical market timer might move from stocks into bonds when they expect the market to pull back, other financial experts caution that bonds are the wrong move in a rising interest rate environment. All the warnings and predictions make the initial exuberant Dow record a frightening position to be in.
So what do you do?
My father and mentor, Alan Kondo, has always liked the adage, “The market timer’s Hall of Fame is an empty room.” It’s true that an 8 year bull market does give rise to concern. However, perfectly timing the top of the market so you can sell to lock in gains and then predicting the exact time to reenter the market before it picks up again is as likely as winning the lotto – twice in a row.
What has historically worked more effectively to provide reliable returns and protect your nest egg is to create a long-term investment plan that you can stick to, in both good and bad markets. Construct a balanced portfolio of equities and fixed income (bonds) that will capture market growth when it occurs, but also provide you a measured amount of downside protection if the market has a pull-back. The exact weighting of equities to fixed income depends on a variety of factors like your retirement date, the return you hope to achieve annually and your personal risk tolerance. A Certified Financial Planner™ can help you customize an asset allocation that is tailored to you.
Success in Short-Term Fixed Income
For some, fixed income has been a difficult component to keep in their portfolio during the last 8 years as equities have climbed at a remarkable pace. Further, with rising interest rates and inflation, long-term bonds may have a difficult road ahead. We should be mindful of how we invest in fixed income these days. The Federal Reserve has already increased interest rates twice this year and four times since 2015[iii], signaling that they believe the economy is still strong. That means you don’t want to lock in a 10 year Treasury at 2.25% now if the going rate is going to be 2.50% by year-end and even higher next year. Instead, now is the time to invest in short-term fixed income, with maturities of less than 5 years and preferably 1-3 years. Employ a laddering strategy where multiple bonds are purchased, each with different maturity dates. Having short-term laddered fixed income means that each quarter, some of the bonds in your portfolio or bond fund will mature. The matured bonds will be replaced with new short-term fixed income at the going market interest rate, allowing your fixed income fund to keep up with rising interest rates and still provide you downside protection if the equity market dips.
Why Market Pullbacks are Good
A market pullback is defined as a temporary market decline in what was otherwise an upward trend in the stock market. Some are claiming that a market pullback is on the horizon that will wipe out the Trump Rally[iv] which has amounted to a whopping 3,000 points on the Dow since President Trump took office last November. A market correction can be as much as a 10% decline, but it’s important to remember that market corrections happen often and are actually indicative of a healthy stock market. Just as the economy has peaks and valleys, so too does the stock market. When the market goes too long without a correction, the risk of stock prices deterring too far from their actual value grows.
Keeping a big picture perspective, in a 20 or 30 year investment window, a market correction is hardly a blip on the retirement radar. So if you have set up a good investment allocation, let your investment ride out that temporary trough and get back on track. Don’t sweat the small stuff.
In the last 20 years, the S&P 500 returned an annual average of 7.68%. However, during that same window of time, the average U.S. stock investor earned just 4.79%. That is an almost 3% difference each year[v]. Mostly this is the detriment of market timing and locking in lows due to panic. Many investors are smart people who could do a good job at investing their retirement funds if they dedicated themselves to it full-time. The benefit of a good financial advisor is the experience, objective advice and guidance that can help keep investors on track and stop them from potentially cutting their long-term returns in half.