Out of the blue, the stock market has started to look shaky. Market volatility, of course, is common, but in recent months the market – still sitting just under all-time highs — has been climbing relentlessly, taking only a few pauses to catch its breath.
Is it time to get out or at least pare back positions?
Almost certainly not. This is a good time to rebalance your portfolio – to make sure your exposure to stocks is what you previously decided, not what it has become. No doubt, many investors are overdue in doing so. Perhaps your original plan was to invest 50% in stocks, a number that has since climbed to 60%. Sell some positions and pare it back to 50%.
Unless your long-term financial plans have changed, however, don’t go further than this. It’s important for annuity owners to seriously weigh this advice because most have no more than half of their financial assets parked in annuities. Market volatility impacts them, even more so if they own variable annuities or fixed indexed annuities tied to the market.
Stock market adjustments should be limited to rebalancing because stocks, over time, have always been the best financial investments. People who try to divine the direction of the market typically get it wrong and ultimately undermine portfolio performance.
There is a huge difference between a trader and an investor. Stock market investors have always won over time. Most traders lose. Timing the market is a fool’s errand, investment pros say.
Temptations to trade exist. A front page story this month in The Wall Street Journal raised a red flag about the stock market. The headline: “Markets Rise in Lockstep, Raising Worries of Reversal.” The article said that stocks, bonds, gold and even bitcoin, the digital currency, have all been surging, setting the stage for sharp reversals. These assets rarely move in unison. The culprit is complacency, the article says, and it comes at a time when key sectors of the economy – the housing, automobile and retail sectors – are in decline.
Some investment experts have dubbed these simultaneously soaring markets a “goldilocks environment.” Such environments never last, and it doesn’t help that the U.S. is in the late stages of an economic growth cycle. Even the most positive sign – strong job growth that has pushed the unemployment rate down to a 16-year low — is a mixed bag. That’s because employee wages have increased only modestly.
Notwithstanding legitimate concerns about the goldilocks environment, most financial planning experts say it would be unwise today to substantially trim equity positions beyond rebalancing. This is not to say that we have not entered or are approaching a correction. Nobody really knows. It is to say, however, that there is no reason to expect a deep and prolonged gut-wrenching selloff, and that those who think otherwise will shortchange themselves.
Dalbar, a leading financial services market research firm, publishes an annual report that shows that most investors make bad decisions, mostly because of fear and greed. As a result, their investments underperform the market by several percentage points. Its conclusion is based on an analysis of investor flows in and out of stock and bond mutual funds.
The upshot, says Dalbar, is that the average investor – one who invests in a blend of stock and bond funds – has garnered only a net 2.5% annualized rate of return over the last 20 years and only 1.9% over the last 30 years. By contrast, the stock market, including dividends, has risen at roughly an average of 10% annually over time. Last year, the S&P 500 returned 12%, while the average equity fund investor earned only 7.26%, Dalbar says.
Mutual fund research firm Morningstar Inc. does similar research and has come to similar conclusions. To spotlight investors’ self-defeating behavior, it uses a metric called “investor returns” – i.e., what average mutual fund investors truly earn. This contrasts with total returns, which is what a mutual fund actually earns.
Morningstar says too many investors sell a fund near its lows, leaving fewer dollars in the fund to take advantage of the upside, and buy a fund near its highs, placing more dollars into stock funds to inadvertently capture its downside.
The only good news here – if you want to call it that – is that mutual fund investors have been somewhat less remiss in the last decade. According to Morningstar, investors in diversified U.S. stock funds have missed 1.8 percentage points of stock funds’ annualized total returns over the past decade because of bad trading.
If this doesn’t sound like a lot, think again. A haircut of even 1% a year adds up big time over a lifetime of investing. If you invest $5,000 a year for 40 years and earn a 6.5% annualized return, this totals nearly $880,000. If you invest the same amount over the same period but earn only 5.5%, it generates $680,000 – or 23% less.
Lastly, you may have heard the concern that an erratic President Trump means that the only direction for stocks is ultimately down. The old saw is that Wall Street hates uncertainty.
Wise investors will take this with a grain of salt. Even if Trump remains erratic and even if Trump goals such as deregulation, corporate tax cuts and infrastructure revival fail to materialize, it may mean very little. Experts say the stock market got a bump early in Trump’s presidency because of the “Trump trade,” but that vanished months ago and has been replaced by robust gains in corporate earnings after years of subpar performance.
If this continues – and the odds seem good – the market can continue to rise regardless of what the President does or does not do.
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