On Financial Markets, It’s Déjà vu All Over Again

by Eve Kaplan, CFP(R) Practitioner

On financial markets “It’s Déjà vu All Over Again” – to quote the late, great Yogi Berra. While he probably was talking about baseball, it applies to stock markets this past month – it feels like same old, same old, all over again. As we close out the month of January 2016, it’s clear the only “surprise” has been the timing (stock markets don’t usually collapse straight off the bat at the start of a year).

If you’re suffering from paper losses and investment hangover, I encourage you to read on.

It’s hard to avoid the endless market commentaries ranging from the Chicken Little approach to very mildly positive forecasts for US stocks this year.  Parsing through the information about collapsing oil prices, China, the US economy and Fed policy only explains so much.

Let’s look at what we try to accomplish when we invest, and how we handle market turbulence:

1. The closest thing we have to a risk-free investment is 3-month US Treasuries.  The current 3-month US Treasury return is 0.32%.

2. To earn more than this measly 0.32% return, we accept that investing elsewhere should give us a higher return  – on average — than the risk-free rate of return. In exchange, we accept more risk (uncertainty). The higher the risk, the higher the expected return.

3. For example, we expect emerging market stocks to return more – on average – than US blue chip stocks. These numbers are borne out over longer time periods. (note: I’ve deliberately chosen emerging markets because they have had an atrocious return the past several years).

4. So why invest in something “risky” like emerging market stocks? As explained, investors expect them to return more than US blue chip stocks over time. Further, having different asset classes helps diversify portfolios because asset classes are not perfectly correlated. You don’t want your entire portfolio in one basket (e.g. US blue chips) and you understand investments that move in different directions help smooth the ride.

In sum, your admission ticket to the roller coaster investment ride means you accept some volatility and uncertainty in exchange for the opportunity to earn more than the 3-month US Treasury return. We can’t anticipate exactly when the investment roller coaster will hit the skids or speed up. We can’t anticipate how large a correction will be. The wisdom of hindsight on Wall Street is a wonderful thing. Wall Street pundits earn their keep by providing fresh market forecasts but this can be very hit-or-miss.

Sticking to a model portfolio that suits your specific growth, income and risk needs is key to riding through these unpleasant bouts of market turbulence. Ask yourself — do you have a model portfolio that you or your broker or advisor stick to because it is tailored to your specific growth, income and risk needs? Or does your portfolio consist of scattered account holdings that seem to go up and down without rhyme or reason?

I view investments as the fuel one uses to get you through your financial goals — whatever they may be. How do you know if your financial goals are realistic or not without a financial plan that integrates all your investments and goals?  Without a financial plan that’s integrated with your investment portfolio, you can’t know how well positioned you are to ride through periods of turbulence or not. Ultimately, a financial plan that is regularly updated can help you minimize the risk of outliving your assets.

Are projections about future investment returns always correct? Of course not!  A good financial plan is an organic document that changes and adapts over time as investment information and financial goals change. Forecasting the future and using past data are imperfect but they’re far better than boarding a roller coaster blindfolded!

If you can answer basic questions about how your investments are allocated and if they’re correct for you (or not), congratulations! If you can’t, a solid financial plan can give you “peace of mind” when markets hit the skids.  A solid financial plan can tell you if you’re in good shape to afford a 2nd home, buy into a retirement community, cover spiraling health care costs, provide financial support to your adult children or cover your other goals and dreams.

(C) Copyright by Eve Kaplan, 2016. All Rights Reserved.