[Editor's Note: This is a guest post submitted by a Katherine Vessenes, JD, CFP®, RFC, the president of MD Financial Advisors, “the personal CFO for busy physicians” where she advises 260 physicians. She has authored three books. We have no financial relationship. This post was submitted back in August during the correction, but is mostly “evergreen” since a stock market correction can happen at any time.]
If you have been listening to the news over the last few days, you might be getting nervous about the increased volatility in the financial markets. You are probably wondering how this may impact your own investments. Some doctors might be thinking of selling their positions and even moving to cash.
Here are a seven things to think about before you do anything drastic and start self-prescribing:
#1 Recognize There is No Free Lunch
The reason we expect higher long-term returns on stocks over cash and bonds is because they have greater volatility. They have higher highs and lower lows. There is no free lunch in the financial markets, and we have to accept volatility in times like this in order to earn the expected higher long-term returns. [Aside from the “shallow risk”/volatility, there is also higher “deep risk” with stocks, another reason long-term returns are expected.-ed]
However, this volatility can be your friend if you are systematically investing every month. When the market is down, your monthly investment will buy more shares. In a sense it is like buying shares on sale. This tends to reduce the average cost per share over time. It also takes the emotional stress out of trying to guess if it is a good time to buy or sell.
Takeaway: If you haven’t started a systematic investing program, now is a good time to get it in place.
# 2 Re-assess your Tolerance for Risk
At our firm, we employ a thoughtful, scientific, long-term approach on asset allocation using DFA Funds. If you are working with a DFA advisor, or another advisor using index funds, then they should have prepared you for today by talking about potential downward swings in the market, before you started investing.
We always begin our asset allocation discussions with clients trying to assess their appetite for risk. I show them the negative returns on different portfolios from the crash in 2008 and ask them at which point are they calling me in tears, begging me to move them to cash. I also remind them there is no guarantee we couldn’t at some point see returns that are worse!
Takeaway: If you are working with an advisor and still having apoplexy over the market, it might be time to rethink your strategy. Make sure you look at all their returns year by year over the last 20 years. Average returns can be quite misleading. For instance, average returns on many 60/40 (60% stocks/40% bonds) portfolios over the last 20 years are close to 8% per year, even after fees. However, in 2008, that mix lost roughly 28% in one year alone. Even in the last 10 years, it managed a respectable 5.5% average annual return, after fees, which included losing almost 28% in one year. I use the last 20 years as a guide because the markets had 10 really good years and 10 bad ones and the returns will look more realistic than returns averaged over the last 30 years.
# 3 Control What You Can
Research says that about 93.6% of your returns will come from how your portfolio is structured[1]. Less than 7% comes from “random error” or being in the right place at the right time—the lucky stock pick. Since we can’t control random error, we focus on what we can control: how every portfolio is structured.
When it comes to structure, we recommend a mixture of international firms and U.S. companies; small companies and large ones; real estate, bonds and commodities.
Research shows that a large part of your returns can be explained by your mix of:
- Stocks to bonds
- Value to growth companies
- Small to large companies
- Highly profitable to less profitable companies
If you are following a thoughtful strategy to structuring your portfolio, your personal returns will be different [and hopefully higher-ed] from those of the talking heads on the evening news.
Just this morning a very savvy pediatric surgeon came in for his quarterly review. One of his accounts that we manage had $900,000 in it as of our last meeting. He had been looking at the news but not his account values. He was sure this account was down to $750,000. When I pulled up his balances, he was surprised that it was only down $50,000, not the $150,000 he had feared. This was a non-event to him. He won’t retire for at least a decade, so he knows he has time to make up the difference. As I review this article one more time, his portfolio is almost back up to $860,000!
Takeaway: Look at your own investments before panicking over the news. Also, your portfolio structure will have a far larger impact on your returns over time than the impossible task of trying to select the right companies at the right time.
# 4 Market Timing Does Not Work
Market timing is the illusive silver bullet of investing. If one could do it at precisely the right time on a consistent basis, the rewards would be fantastic. However, it is not possible to accurately predict the market, despite much media advice to the contrary. In all of my years in this industry, I have not found any firm or individual investor who has consistently timed the markets with success over the long haul. I can say this even though I once served as legal counsel to the 9th largest mutual fund board of directors, and every month more than a dozen portfolio managers reported their returns to us.
Although this silver bullet does not exist, the good news is that one does not need a crystal ball to invest with success. The benefits of a long-term, patient viewpoint are compelling because the higher returns you will get from stocks is dependent on being disciplined through both good and bad times for the long run.
Takeaway: if you are more than 10 years from retirement, you should probably sit tight. Selling now could guarantee your losses. [And if you are less than 10 years from retirement you should probably sit tight in a correction, not only because panic selling is rarely a good idea, but also since you're probably 20-50 years away from spending most of your money-ed.]
One of the saddest cases I had was two family med docs who came to me as clients last year. In 2008, at the beginning of the year, without any professional advice about the risks in the market, they set up a 401-k invested 100% in stocks. By the end of the year, they had lost 50%. They freaked out and sold all their positions, thereby moving paper losses to actual losses. In fact, if they had just held on, in three years, they would have had all of their money back, and in four years, they would have had a great return.
# 5 Remove Your Emotions from the Situation
There is no doubt it is really stressful to lose your hard earned dollars. Yet, letting your emotions guide your investing strategy will reduce your returns over time. There’s a very famous research group called Dalbar, which studies investor behavior. One of their studies they do every year is how the average investor does compared to the S&P 500 stock index. As of 2014, the 20 year annualized S&P 500 return was 9.85% while during the same time period the average equity mutual funds investor was only 5.19%, a gap of 4.66% each and every year. It shocked us to see how poorly the average do-it-yourselfer did compared to the index. [A minor point, but the famous Dalbar study significantly overstates what is likely a very real behavioral effect. Investor returns will always trail investment returns in a rising market and vice versa due to ongoing contributions.-ed]
The reason the average investor does so poorly is summed up in the picture below. They become elated when prices are high so they buy high, and become fearful when prices drop and so they sell. Buying high and selling low is the exact opposite of any good investment strategy.
Takeaway: Unless you are as savvy as the White Coat Investor, and have lots of time to do the necessary research, investing on your own can be dangerous, even for doctors, because it is so much easier to give in to your emotions during a crisis. Like the famous investor Benjamin Graham once said, “the investor’s chief problem—and even his own worst enemy—is likely to be himself”. [While I think hiring an advisor is probably going to reduce panic selling in a correction, advisors unfortunately aren't immune to this phenomenom, so be sure to see what your advisor did personally and professionally in 2008!-ed]
# 6 The Importance of Diversification
Diversification is one of the easiest things you can change, yet I can’t tell you how many new doctor’s portfolios we look at on a daily basis that are missing valuable types of assets that would make them more diverse. Owning a mix of different types of assets provides a smoother and more stable ride for your long-term portfolio. This includes large cap, mid cap, small cap, internationals, emerging markets, bonds, commodities, and real estate.
Below you will see a “world map”. It shows each country by the percentage of publicly traded companies headquartered in each country. Almost half of the stock markets exist outside of the United States, which is why we include those in all our portfolios.
Takeaway: Look at your portfolio to see that it is properly diversified.
#7 Time Is On Your Side
We work with over 200 doctors around the country. Fortunately, not one of them needs their investments liquidated this year.
Since the beginning of the stock market in 1926, there have been 22 times where the broad US stock market has been negative. Therefore, 67 of those years have been positive or 75% of the time the market has moved up. Those are great odds. In other words, the majority of the time the U.S. stock market is up and growing. The stock market has historically rewarded investors for holding onto their investments even when the market goes down. You can see this on the graph below.
In addition, it’s important to remember that markets historically have rewarded investors after a crisis. You’ll see on the second graph below, historical crisis periods in a portfolio of 60% stocks and 40% bonds. In the six periods shown, five of them had positive growth within three years, and 100% of them had high positive growth within five years.
Final Takeaway: There is no need for Prozac. It is not time to panic. Sit tight!
What do you think? What did you do in the correction of 2015? How do you plan to survive future corrections and bear markets? Comment below!
Can you enlarge the three graphics in points 6 & 7 so they are actually legible when clicking on them?
Yes, those look terrible don’t they. Let me see if I can fix them. That was one of the best parts of this post.
They look a lot better now. That’s as good as I can do with the files I have, but I think it looks good enough now. The other thing you can do is use control + or on a mac command + to enlarge the page, but that won’t do much for resolution.
They look much better.
I take serious issue with this article as any good investor or proffessionl money manager should know that a low volatility portfolio of stocks has been shown to provide a significantly better risk adjusted return than a traditional high beta approach to investing. That is the entire reason that ETFs such as SPLV, USMV and EEMV exist. It is called the low volatility anomaly and flies in the face of the Capital Asset Pricing Model which is clearly what the author is siting.. ie for a given amount of risk a proportionate return is to be expected but once again lower risk/lower vol has been proven to provide better risk adjust returns. Rather than providing a series of links I would have you google “low volatility anomaly”. The same goes for market timing.. Picking a top or bottom is impossible however it has also been show by such astute investors as Jeremy Seigel that using a 200 day moving average to dictate when to be in the market and when to be out provides significantly better risk adjust returns than a buy and hold strategy. Again something you can google and implement yourself in excel. It is about risk management. Simply owning the stock market and hanging on is not a good risk to reward.. Lose 55% of your investment in a matter of months to spends years trying to make it back is a terrible risk to reward. Protect you downside first.
After I finished paying off student loans in 2014, I started an after tax investment account at vanguard after running out of tax advantaged accounts. Problem is – I put in the bulk of the money (~350k) into the market from late 2014 to mid 2015 – distributed roughly in 1/3 total US stock, 1/3 international, 1/3 interm tax exempt muni bond. However, about 25k of that went into emerging and energy funds (yes stupid, should have kept it simple doh!) and those have been totally smashed. Now, the total US stock market is slightly up, the muni is steady, but the international/emerging/energy is down quite a bit. Overall, my returns for the last year for my after tax account is probably at 0.5 – 1%. Blah .. but at least I didn’t sell and do not intend to. During the August correction, put in another chunk that week and that has helped overall with the rate of return for the account. However, it IS very difficult seeing my hard earned money earning little/nothing and/or losing value… quite depressing actually 🙁
On the flip side, my brother in law who is an absolutely brilliant egghead PhD (he works at Princeton Univ as a tenure faculty member in electrical engineering) has taken the opposite approach. During Thanksgiving dinner, he told me he sold everything during the 2008 slump and has been “waiting” for the right moment to get back in. Problem is – he never got back in and has missed the huge bull market in the last few years. I recommended him to read your site ASAP. Hopefully he will soon.
Dooh… Never get totally out of the market.. I hope he starts to get back in too…
High IQ doesn’t necessarily improve your investing, does it? It turns out it is more about behavior and a solid knowledge of market history.
As far as your own investments, you’re talking about less than a year, a mere blip in your investment horizon. Focus on the long term. If I wasn’t writing a monthly newsletter, I wouldn’t even look at what the market is doing on a monthly basis. It just doesn’t matter. I don’t need any of the money I’m investing a year from now.
I agree with your assessment of high IQ does not correlate with being a good investor. I feel bad for him and hope that he reads this blog and gets back in the market ASAP. And yes, in terms of my own investments – you are absolutely right that one year is simply a blip in my time line (well, maybe a dip because I am 40 and plan to retire in 15 years if possible). I just have to keep that in mind and not look at any market news for a while!
Great piece VERY VALUABLE info The buy and holders WIN(do not forget to REBALANCE yearly)
The most important piece of information, other than indexing, is the marginal utility of wealth(gleaned from Swedroe’s book)
BASICALLY when you reach your goal it is much more important to preserve your capital rather than looking for big gains
Most when they retire will need income from pension to live on
If you can save 20% more than you need, you have the ability to take a more aggressive approach
Love individual tax free munis
GO better than Revenue
Investment Grade default rate is miniscule
I always bought LONG TERM as I knew I would not need the funds
There is a built in spread 1-2%
You buy individual munis? I have been researching munis in general due to maxed out deferred space and the obvious tax free benefits (in Cali as well). The part about individual munis that seems tough to me is the illiquidity when buying and thus spreads and slippage can seriously hurt. CEFs, all super leveraged and no touch until a rate hike materializes and the effect is obvious, which leaves mutual funds and a couple ETFs.
Whats your individual muni tips?
RE: #4 on market timing.
I’m a closet market timer, so moved some cash to equities when the S&P dropped 10% to 1850. I’ll off load again when it hits 2300.
why individual Munis instead of a fund? I am in VWITX now
Individual munis will pay higher and although the price fluctuates, at maturity you get back 100%
sold in 5k denominations
I have had them for 40yrs-great for after tax money-they are very liquid as well
I disagree they’re liquid. I would not buy individual munis if liquidity were your goal. A muni bond fund is a far better choice for those who need liquidity.
Respectfully disagree as I have sold them quite easily with vanguard
Nice to build up a diversified portfolio of muni bonds that generate nice monthly income
Nowadays I think you are talking 3.5-4% long term
Like stocks as you buy them regularly you average out
Do your homework
It worked for me and keeps on working
I’m not saying you can’t sell them. I’m saying you’re paying a pretty good spread to do so. The spread is so large you would likely be better off paying the additional expenses of a bond fund if you’re selling very many of them.
I sold some individual munis in the 2008 panic and they were not liquid at all. I use funds now.
Even the funds arent that liquid, low volume on average, which is great for stability but an individual certainly could move the price around just buying and selling an amount in their own account.
The Vanguard muni funds don’t have their price moved around by buying and selling in your account. It’s determined by end of day NAV. You’re thinking of bond ETFs, which bring in additional issues.
Yes, I was talking about the ETFs. ETFs in the muni bond space are interesting in that it is one area where the set up has not seemed to be able to result in lower overall costs than mutual funds since the volume is just not large enough. Since you can get vanguard with no/waived loads its even harder. Interesting topic.
Bernstein gives a very good argument against bond ETFs. Can’t remember in which books though. One of the newer ones I reviewed now too long ago. Here it is: https://www.whitecoatinvestor.com/rational-expectations-a-review/
Reminds me I was planning on doing a post on that subject.
That would be a great post as Im looking into munis as I make more and want to place something in taxable accounts, but without large volatility or tax problems. CEFs are constantly touted as great, but when you look into them its hard to find any without 30-40% leverage, which is too much for my liking (for the type of account Im looking for, ie low stress) in a non transparent structure with rate hikes coming. Individuals have horrid spreads, leaving mutual funds as best it seems, which isnt that bad really.
I bought that book but its a couple down the queue still, I’ll have to move it up.
instant liquidity to something that is not instantly liquid? Not hard to do the math on that one.
My philosophy was to buy very long term individual bonds from my state and hold to maturity
with a million dollars you can have a diverse portfolio with higher yield because bond funds have varying maturities
individual bonds like cds should be bought with the idea of holding till maturity
trading munis does not make sense because of the spread
I agree. That’s why I consider them somewhat illiquid.
When I first started investing on my own, I’d check my accounts almost everyday (I know that’s bad). It didn’t last too long, maybe a couple months. I just tell myself that the short-term ups/downs are irrelevant, I won’t be retiring for 30 years. I have my TSP contributions automated every 2 weeks; for my taxable account, I usually do it around the first few days of the month. I stay away from the market news/noise; but if I do hear about a downturn, I take it as a reminder that it’s time to do my monthly investment (if I haven’t already). I think my investment plan is sound, so it’s my job to be consistent with it.
I think I did that (not daily but quite often) for the first year, then again in Fall 2008. After 2008, regular market ups and downs seemed so boring in comparison that mowing the lawn was more fun.
I believe no one can time the bottoms and tops consistently or even most for the time because there is no one formula but I might be a closet market timer though… I’m already fully invested so I build up cash savings from salary (which is around 1% of my portfolio every month) until I find beaten up stocks due to market panic or overreaction that I determine are valuable for the long term and then buy them when they are significantly below their highs and if they keep falling, I buy them in tranches. If you believe that they will be good stocks for the long term, then any decline is a great opportunity to get them at a good cost basis. I have been doing this for years and this has worked for me quite well. I don’t get the exact bottoms but I love when stable companies that have stable revenues, growing profits, cashflows and manageable debt get beaten up so bad by the broader market that you just can’t find a good reason not to buy. Some examples are AAPL between Oct 2012 to Mar 2013 sinking due to inflated analyst expectations and rumors inspite of growing revenues, earnings and a cash pile that they had hinted would be returned in dividends and buybacks to investors, MCD (McDonalds) during a bad 3rd quarter in 2012, REITs like DLR, OHI, O, HCP, WPC during taper tantrum in May 2013, Biotech like GILD and AMGN because of a few words from Yellen last year and then again this year when GILD beat earnings, revenues and announced a dividend and buyback policy but guided lower and sinking significantly. TGT (target) in late 2014 due to the hacking scandal and Canada troubles, Airlines like LUV, ALK, DAL during the Ebola panic last summer and also this year too all the while when oil was tanking, they were growing earnings and revenue and were cashflow positive with greater returns to shareholders through buybacks and dividend increases, Refiners like PSX during oil getting pummeled in late 2014/early 2015 with the general market ignoring that refiners actually do quite well in low oil priced environment etc etc…. I like owning dividend stocks because I don’t know when to sell and the dividends are a great way to indirectly sell and rebalance every quarter to other areas of the portfolio that are beaten up without incurring transaction costs
I think all of the arguments made by this adviser can be used as arguments to use a diversified robo-adviser like Betterment. The only thing extra is offering advice to hold the course when markets get volatile, but one can figure that out one’s own.
I took advantage of this recent turbulence to tax loss harvest (without me lifting a finger!) and to transfer a portion of my 35% stock Betterment account into a 75% stock Betterment account. Such a strategy, along with dutifully buying into the down account to dollar cost average away, has been good: on a ~$45k total balance I have ~$1,500 in harvested losses, a 1.6% time-weighted return on the 35% stock portion, and a 6.8% time-weighted return on the 75% stock portion.
Buying and selling stocks is just plain foolish
All historical data point that out
You have a 1 in 2 chance of buying at the right time and the same when selling
You can be right 25% of the time
Take the money and to index funds while you are ahead of the game
No one can play wall st and win, other than buffett
i tax loss harvested my way out of some actively managed mutual funds (unfortunately, not all of them), bought some vanguard funds, and tax loss harvested them some more on the way to the bottom. it was an interesting experience to implement something i’ve read about for almost a year. now we’ll have a little bit of a discount on tax returns for 3 years. then i kept dumping any cash i had outside of the emergency fund into the market, favoring the beat up asset classes.
did not mess at all with tax-deferred account, other than doing some conversions out of a small traditional and small sep ira to roth. and bought more REIT in the roth ira, as was waiting for that one to become “cheaper”.
it was good timing for me, as i got to do what needed to be done while minimizing tax consequences.