After a remarkably calm and wonderfully positive stock market in 2017, volatility has come back with a vengeance of late. It seems like every day involves a multihundred-point swing for the Dow Jones Industrial Average.
The two most common questions I’m getting from clients, many of whom are lawyers, are probably the same two questions you’re asking: Why is this happening, and what should I do about it? I’ll do my best to answer both of those questions.
Why is this happening? Unfortunately, it’s impossible to know exactly why the stock market does what it does. You can, however, make some educated guesses as to what may be driving market behavior. The way I see it, there are two major themes carrying the day of late.
Trade uncertainty. The current trade disputes with key U.S. trading partners such as China are creating a dark cloud of sorts over the market. The lack of clarity on how these disputes may get resolved is leading to investors selling first and asking questions later, especially with respect to international stocks. International economies, notably China and emerging economies, are export-driven, so this trade uncertainty has led to negative returns all year for international stocks following a stellar 2017. Interestingly, for the first three quarters of 2017 U.S. stocks were doing quite well, an indication that investors were not too worried about the trade disputes negatively affecting U.S.-based companies. This makes sense since the U.S. economy does not rely heavily on exports to fuel growth.
Interest rate uncertainty. Many market pundits believe that what set off the latest round of volatility, which has erased much of the gains U.S. stocks had amassed through the third quarter, is a worry that the Federal Reserve will become more aggressive in raising interest rates. The fear is that, if the Fed moves more quickly to ratchet up interest rates, it could slow down economic expansion and potentially lead to a recession, which of course would be bad for stock returns. The impact of interest rates on stock market behavior was evidenced on Nov. 28 when the Dow rallied over 600 points in one day because Fed Chairman Jerome Powell made comments that market watchers interpreted as an indication that he will move more slowly in increasing rates.
So, now that we’ve talked about why the market is misbehaving, let’s move to what you should do about it.
Remember volatility is normal. One of the sayings I’ve used over the years in counseling clients through the rocky times is that volatility is the price of admission for the stock market. If there were no risk, there would be no return. Sadly, volatility is part of life for the stock market investor. That said, no one expects you to like it. You just have to put up with it in order to get the benefit of owning stocks. Last year was a very atypical year for stocks. Everything worked and pretty much went straight up with almost zero volatility. That is decidedly abnormal. In fact, since 1980, the average intra-year high-to-low decline for the S&P 500 is almost 14 percent. Despite this “normal” volatility, the market still posted a positive return in 29 of those 38 years (Source: FactSet, Standard & Poor’s, J.P. Morgan Asset Management). So, when volatility rears its ugly head, just try to remember that it’s nothing new.
Maintain a long-term view. Over the past 90-plus years, the U.S. stock market has averaged almost a 10 percent return. Very few of those years, however, actually had a return close to that average figure. Many years have been higher than 10 percent, and many have been lower than the average. The trouble with averages is that you only get to experience them if you stick around for a while. I’ve quoted this stat before, but it bears repeating. Over the past 20 years (1998-2017), the S&P 500 has averaged 7.2 percent. Meanwhile, according to a Dalbar Inc. study, the “average investor” has only mustered a 2.6 percent return over that same time period.
Why such a huge disparity? The problem is that investors often lose the long-term perspective and try to time the market. When stocks hit a rough patch, they bail and go to cash, hoping to hide out for a while and then go back into the market when things settle down. The trouble of course is that, by the time things settle down, the market has moved considerably higher and the investor ends up getting back in at a higher price, thus completing the dreaded round trip of selling low and buying high—the exact opposite of what you should do. To avoid being “the average investor,” find a stock-bond mix that is right for you and stick with it, even when you hit rough waters. You are much more likely to achieve the average returns of the market if you keep this long-term view.
Make lemonade. When stocks take a dive, it’s important to keep your head about you and continue to make good decisions. One way you can do this is to take advantage of your losses. Now, you might be thinking: What possible good can come from losing money? One portfolio management technique that can add significant value during the tough times is something called tax-loss harvesting.
Here’s how it works. Let’s say you own a mutual fund that you bought for $15,000 and it’s now worth $10,000. Instead of doing nothing, you could sell that mutual fund, which would realize a $5,000 capital loss. At the same time, you could buy a similar mutual fund with the $10,000 proceeds from your sale so that you remain invested in the market. The $5,000 loss that you “harvested” can be used to offset future capital gains you may have in your portfolio, so that loss becomes an asset to you. This “tax-loss harvesting” strategy is a good example of being proactive and continuing to make wise decisions about your money even amid the storm.
Warren Buffet is credited with having said that “investing is simple, but not easy.” Hopefully, by bearing in mind these few reminders, you’ll be able to make your investment experience a little easier.
Important Disclosure: Investments involve risk and past performance may not be indicative of future results. Balasa Dinverno Foltz LLC) investment and wealth management strategy recommendations may not be profitable, suitable or equal historical performance. BDF’s current written disclosure statement discussing advisory services and fees is available for review at www.BDFLLC.com or upon request.
Justin Peacock is an owner and wealth manager at BDF, a fee-only wealth management firm based near Chicago with assets under management in excess of $4 billion. BDF serves clients nationwide. Peacock provides financial planning services specifically tailored to addressing the distinct needs of lawyers. He can be reached at jpeacock@BDFLLC.com.