Does the Stock Market Have You Reaching for Prozac?

[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 9^th 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!