Sep 8, 201511:28 AMOpen Mic
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And the stock market outlook is … who cares?!
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The recent volatility in the markets has stirred a lot of heartburn with investors. Financial outlets such as CNBC are going crazy with prognosticators predicting what the market is going to do next. This is great entertainment, but it shouldn’t guide you as an investor.
No one can consistently and continuously predict fluctuations in the markets. (Note how CNBC never keeps a running scorecard of its talking heads’ market predictions — it would likely embarrass them.)
You should not be focused on variables beyond your control
Moreover, you as a prudent investor shouldn’t be trying to predict market fluctuations, nor should they affect a sound financial plan. You cannot control what the market does, and you should not be focused on variables beyond your control.
Instead, you should only be focused on variables you can control. Any historian of the market knows it continuously and repeatedly goes through cycles of getting overheated followed by massive corrections.
The stock market will most assuredly continue its volatile cycles of exuberance and crashes because emotional human participants are what drive markets. Especially amusing is the market history of the tulip mania during the 1600s when, for a short time, a single tulip bulb sold for the equivalent of several years’ salary of a skilled craftsman.
There was also a period during our recent history, in the 1990s, when investors began to believe the stock market had entered a “new era” and would forever continue its double-digit upward climb because of the new Internet economy where profits didn’t matter. Most of those believers finally came back to reality after the crashes of 2000–02 and 2008.
A sound financial plan is prepared for volatility and crashes
Your job as an investor (or your advisor’s job) is to craft a fundamentally sound financial plan that is prepared for market volatility and market declines. If the success of your financial plan and financial well-being are dependent on what the market does this year or even during the next three to five years, then you have a bad plan.
Let me repeat that point another way, because it’s the most critical piece of this post: The success of your financial plan should not depend on what the market does this year or even during the next three to five years. If it does, then you have a bad plan.
The statistics from our past three major bear markets prove this point. I will get into the details of those in a minute.
I am consistently surprised by the number of people nearing retirement I meet with who have practically all of their retirement savings exposed to market risk. When I ask them why their entire portfolio is exposed to the market when they know they'll need some of this money in just a few years, they tell me they don’t want to miss out on a big run-up in the market.
When I ask them what would happen to their retirement plans if instead the market suffered a 30% decline, a typical response is they don’t plan on that happening. As politely as I can, I try to explain that 1) the market doesn’t care about your plans, and 2) the market doesn’t pre-announce a decline — you’re typically in the middle of it before you realize it.
Lessons from the past three major bear markets
Let’s take a look at the major bear markets of 1973–74, 2000–02, and 2008, and the lessons you should take away from those. First, let’s examine the important statistics from those three bear markets.
Crash of 1973–74
One dollar invested in the S&P 500 at the end of 1972 fell to about $0.63 by the end of 1974, a two-year drop of 37%. (Note each of these examples assumes you reinvested dividends. Without dividends, your declines would have been even worse.) It was not until six years later in 1978 that the market permanently restored your dollar back to the break-even point and started growing it.
Crash of 2000–02
If you invested $1 in the S&P 500 at the end of 1999, it fell to about $0.62 by the end of 2002, a three-year total decline of 38%. Your dollar briefly got back above break-even in 2006–07 but fell significantly again after the crash of 2008. It was not until 2010 (10 years later!) that your dollar invested at the end of 1999 permanently made it above break-even (so far, anyway).
Crash of 2008
Finally, $1 invested in the S&P 500 at the end of 2007 fell to about $0.63 by the end of 2008, a decline of 37%, and it was not until five years later in 2012 that you recovered that dollar and stayed above break-even.