What’s Best? Listen to Experts or Update Your Appetite for Risk
This is a dangerous time for investors because a stock market that delivered almost 30 percent returns to almost all stock categories for 2019 will leave us trapped in the belief that it will continue. Pundits and Wall street strategists throw gasoline on that fire by declaring how much the market will be rising this year. So, Jeff Sommer in the New York Times recently threw water on any semblance of accuracy on those predictions.
Mr. Sommer pointed out that a study by Bespoke Investment Group found the median of all annual predictions to be off by an average of 4.5 percentage points. In other words, if the average prediction for the 500 Index was 9.8 percent, the actual result was 5.5 percent — a 45 percent error. The consensus was even wrong about the basic direction of the market about 30 percent of the time. Some of the worst examples are just laughable — like the experts’ prediction for 2008 which called for a 11 percent gain which, in fact, was a 38 percent loss.
Our challenge today is to sift through the rosy predictions that fueled the stunning gains of 2019 — piled on top of a tripling of market values over the past decade. Today’s market values always reflect the anticipation of future profits. Consumer spending, presumably, is predicted to increase enough to offset what is already a slowing of manufacturing gains. These factors, plus low interest rates, are the basic underpinnings of today’s market performance. Unfortunately for us, stock values are based on the “voting machine” of human behavior.
What can happen is that investors, now confusing brains with a bull market, can get ahead of themselves and throw all caution to the wind. Many of us should recognize that we’re too old for that. Looking back over twenty years, it is reassuring to see how combinations of stocks and bonds have actually generated returns that were far less volatile and that generated reasonably similar results to portfolios invested totally in equities.
Personal risk profiles are like snowflakes. Each one is unique. Every investor has to ask themselves how much money they can stand to lose. At what percentage amount would they experience a level of depression, if not hardship, that would be unbearable. Then, take a look at various combinations of stocks and see how past results of the different asset classes compared over time — paying special attention to performance in falling markets. Large company, dividend-paying stocks are by far the most stable but long- term performance is lower than other asset classes.
Moving on from stocks, recognize that various stock/bond combinations generate progressively less volatility as the bond component increases. The gold standard is two thirds in bonds. This combination will rarely lose money — typically less than 5 percent in a rare losing year. For one popular balanced fund, that loss happened just seven times over the past 50 years. That said, the bond-heavy combination still averaged about a seven percent annual return. The combination gained over 15 percent this past year alone after losing just 2 percent in 2018. For further confirmation of these expectations, we note that the so-called “Target date” funds popular in many 401(k) plans move automatically toward this two-thirds/one-third bond/stock combination over time, arriving there and staying there once the investor reaches retirement age and beyond.
While the economy appears to be admittedly strong, there’s yet another dimension of risk to consider. It’s what known as “The Black Swan” event — a totally unanticipated event that upends the market. The two most recent collapses — the dot com bubble bursting and the financial system collapse would qualify. If you think the world could be more vulnerable than usual to such an off-the-wall experience today, it might be reassuring to know that the bond-heavy allocation lost about 9 percent in 2008 while the overall market dropped almost 40 percent at the time.
This is a time to factor these basics into the mix as you re-visit your personal risk profile — that personal risk profile that only you can determine.