During a holiday gathering, a family member made the following toast: "May 2016 be as good as 2015 was bad."
To start the year, investors may have felt the same way. Bloomberg called 2015 “The Year Nothing Worked” as stocks, bonds and cash all went “nowhere.” US stocks (S&P 500) were up 1.4%, International stocks (MSCI World ex/US) down 3.0%, Bonds (Barclays Aggregate Bond Index) were up 0.6% and cash returned 0.0% (Short-term Treasuries). Outside of Emerging market stocks and commodities, it was a pretty uneventful year.
However, “nowhere” sounds pretty good so far in 2016, with the S&P 500 officially off to its worst start to any calendar year.
But as Ben Carlson, author and Director of Institutional Asset Management at Ritholtz Wealth Management, recently wrote, “Sometimes stocks go down. That’s why they’re called risk assets. Half of all years since 1950 have seen a double-digit correction in stocks. Get used to it.”
In fact, since 1950, there have been just four years — 1954, 1958, 1964 and 1995 — where stocks didn’t have at least a 5% correction at some point during the year according to Carlson.
The blame for the dismal performance is placed in many corners: China’s economy is slowing, the collapse of oil prices, the Fed raising interest rates. But, the bottom line is this: in a global marketplace, made up to millions of buyers and sellers, each with their own wants, dreams, fears and ideas, selloffs like we are having are impossible to predict. They only thing of which we are certain is that they happen, and this won’t be the last time.
As a result, there is a "risk premium" available to those willing to own stocks long-term. In other words, corrections like this are a big reason stocks have returned more than bonds over time (the gap between returns on stocks and bonds is called a “risk premium”).
It's simple as a concept, but at times it’s difficult to maintain as a strategy. Investing in stocks: straightforward, but not easy.
A few things to keep in mind
To help ease that difficulty, here is some perspective.
According to Ryan Detrick, the year immediately following a flat year for the market (defined as S&P 500 returns between -3% and +3%), the market experienced an average return of 18.9% and was higher in all seven occurrences.
Another thing to remember is that no matter your age (20-60+), chances are you have several decades ahead of you to invest. Viewing these market selloffs as opportunities tends to work out pretty well. See the graphic below. The last nine times CNBC has aired the “Markets in Turmoil” special report it’s been a good opportunity to buy.
This chart is the visual illustration to one of Warren Buffett’s many famous lines: “Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy when others are fearful.”
Additionally, as we saw earlier (only 5 years since 1950 have been without a drawdown of at least 5%), drawdowns are common. According to JP Morgan, the average intra-year drop from the S&P 500 index is 14.2%. Despite this, the index had a positive return in 3 out of every four years since 1980. The market rewards those who are willing to take the long-term view and stay disciplined in their investing strategy.
What Can You Do?
Getting perspective helps. But, even though it is often the most prudent approach, sometimes doing nothing is actually the hardest thing to do. As Blaise Pascal once said, “All of humanity's problems stem from man's inability to sit quietly in a room alone.”
Too much action—and certainly the wrong actions—can be detrimental to your portfolio. But, is there any action you can take that is useful? Maybe. Here are some things to do now.
1. Diversify Internationally: Only around half of the global stock market is U.S. based. There are a lot of opportunities in the international markets. And the International markets are cheap compared to the U.S. One of the things we regularly see in the investment portfolios we review is a bias toward U.S. stocks. If this is you, use this as an opportunity to reevaluate your position and seek international diversification as a source of higher returns.
2. Keep the long-term in mind: Take a look at the chart below. What you see is that almost anything can happen over a one-year period. The best return on a portfolio of 50% stocks and 50% bonds since 1950 is a 33% gain, but the worst return is a 15% loss—a whopping 48% difference between the two extremes over one year. But, as you extend your holding period, results tend to become less noisy. Over ten years the worst return for this portfolio was 1% (with a 20% spread between the extremes) and over 30 years the worst return was 5% (9% spread).
3. Review your risk positioning: We just reviewed how common it is to have a drawdown in each year (remember, the average intra-year drawdown is over 14%) but that returns go to those willing to take a disciplined approach. A big part of being disciplined is not taking on more risk than you can bear. If you are a client, you know how much time we spend talking about the level of risk we are taking and making sure it's the right level for you. For everyone else, start by getting your risk tolerance right.. Until you get this right, every other part of the investment process is secondary.
4. Tax-Loss Harvesting: Drawdowns create opportunities for tax-loss harvesting. Tax-loss harvesting is a way to take any losses in your portfolio to offset income or other gains in the current year. (See our white paper “Managing Investment Assets in Retirement” for more).
By selecting an appropriate replacement fund, you can get a tax benefit while staying invested and remaining positioned for a rebound in the markets.
While a flat year, like we had in 2015, and a rough start like we are off to so far in 2016 are not fun, they are part of the practice of investing. The best investors tend to be those with a deliberate approach and the discipline to ride things out during the rough patches.
Or, as Warren Buffett said, "The most important quality for an investor is temperament, not intellect."