The 1967 hit performed by Smokey Robinson And The Miracles, "I Second That Emotion" is a song about the emotion of love. If you are in equities, you're probably not going to "second that emotion"! Considering monthly and quarterly statements are going out this week and the volatility that we are experiencing; the subject of financial emotions and specifically, some steps to take that will lessen the emotion of fear, seems timely.
As I write this, the market (S&P 500) is off 20% from this year’s high. That is the definition of a bear market. It’s nothing new. We experienced it in 2020 and 2022. As I wrote in February, I am not surprised and even today, I certainly would not be surprised to see more downside.
There are two reasons why.
1. Valuation: The price to earnings ratio is simply how much you are paying for a company’s earnings. The higher, the more expensive the market is. The lower, the cheaper it is. As you can see from the chart below, the thirty-year average is 16.9 and as of March 31, it was 20.2. That means the market, if earnings were to stay the same, would have to fall 16.3% from the levels we saw on March 31st JUST TO BE AT THE AVERAGE. As I write this, the market has fallen approximately 9.4% since March 31st. Remember that is IF earnings stay the same. If earnings are going to decline as the experts are predicting, the market has to fall even farther to get to an average historical valuation.
As I’ve written in these missives before, the PE ratio can stay elevated and irrational for long periods of time. But when an event happens that threatens earnings growth, money managers will anticipate the effects and sell. That is what we are seeing today.
2. Tariffs: The aforementioned “event” is Tariffs. This is the main story if you turn on the news. The truth is, no one really knows if and when this will end and what the long-term effects will be. With that said, the market and investors do not like uncertainty. Even this morning, social media was spreading a story that there would be a 90 day freeze on tariffs and the market immediately went up. The White House quickly released a statement that the story was “fake news” and the market went down.
One thing is for certain, President Trump is hell bent on bringing manufacturing back to the United States and was obviously not joking when he said he would use tariffs to do it. Either manufacture here or pay the price. As said, no one knows what is going to happen. There is potentially a lot of good that could come from this. There is also a chance that it back fires and completely wrecks the economy. We just don't KNOW. I have my opinion but for the purposes of this blog, I'll keep it to myself. Regardless, my advice for you: prepare for higher prices, buy American, support your local small businesses and consider employing the steps I give you below.
Emotion: What I do NOT suggest is making drastic decisions using emotion rather than facts, history and rationale thinking. This goes not only for your personal life but financial life as well. In the financial industry, we deal with two primary emotions that clients struggle with when making financial decisions: fear and greed.
I will touch on greed briefly, but I want to focus on fear since that is what we are seeing with investor’s today. When markets are high and rising higher, I tend to see an investor take excess risk than what they should. The thought is rising stock prices will continue, and “I don’t want to miss out”. You don’t know how many times I have heard an investor say, “my brother-in-law just bought a boat off of his gains from XYZ. I want a hundred shares of XYZ". Usually at that point, the market has already risen, and the risk outweighs the return. But euphoria and then greed settles in and bad decisions are made.
Fear is the exact opposite. When markets fall and continue to fall, we naturally fear the possibility that it won’t end, we won’t retire, and we won’t live the lifestyle we had planned on. Investors may sell into a falling market and then are faced with an even harder decision, when to buy. Selling is the easy part. Buying back in is very difficult. Many investors have sold at the bottom of a market, sat in cash only to watch the market rebound essentially locking in their losses.
It’s like driving a vehicle for the first time after you’ve had a head on collision. You don’t forget that accident for a long time and even though you must drive to work, anxiety sets in and you anticipate a crash happening again. This is totally natural, but at some point, you have to get back in the car and drive!
So what do you do as an investor to manage fear and hopefully not even experience it?
1. Remember why you invested in the first place and re-visit your time horizon: Did you invest to speculate? Did you invest to outpace inflation? Remember why and if that has changed, speak to your financial advisor about it (you should revisit your goals and time horizon annually with your financial advisor anyway). If your time frame is over ten years, you have the time to make up the losses that we see on average every three and a half years. If your time frame is less, see my next suggestion.
2. Manage your risk: Take a look at your overall allocation. Does it mirror your tolerance for risk? We can easily do this for you by entering your investment totals into a risk analysis program that we use. The report will show you what the investments have averaged but also what they did in some of the worst bear markets like 2000-2002, 2008 and 2020. If you would like to have this report, please call to set an appointment and bring your investment statement(s) with you when you come in.
If you are two years from retirement or even in retirement, there is no way you should be 100% equities UNLESS you are in some type of protected investment, or it is an account that you have labeled “speculative”. The account that you are going to count on for income should have some portion of stocks (to outpace inflation), bonds (to provide safety and income), Alternatives (for those times the market goes down) and money market (cash). By having a balanced account, the volatility that you experience will be much lower than an account that is 100% equities.
3. Rebalance at least annually: Once you have the allocation you need, you still have to manage it. The reason is markets go up and become risky. At that point, because you are up, your allocation will be higher in stocks than it should be. Conversely, when the market goes down, you may have too little in stocks and too much in fixed income. In either scenario, re-balancing forces you to buy low and sell high. Some 401-ks and investment programs have automatic triggers that you can set to take the timing and work out of it.
4. Think rationally: If you are either fearful or greedy, recognize it and have a talk with your financial advisor about it. There have been many volatile markets over the last twenty-eight years of my career where I have had hard conversations with clients. A good financial advisor does not use emotion to make financial decisions. They gather the data, analyze it with reason and give you un-biased advice that is in your best interest.
5. Dollar Cost Average: This is simply investing monthly, quarterly, semi-annually rather than in one lump sum. If you are participating in an employer sponsored retirement plan, you are already doing this. But do not neglect 1-4.
If you are retiring and performing an IRA rollover, follow 1-4 and consider setting up the lump sum to invest over a six month or one-year period rather than at one time. This mitigates “entry risk” and this can be a really big risk especially to a retiree.
Next month, we are hosting a lunch and learn about this subject at our office. There are only sixteen available seats. If you are retiring soon, this would be a great use of your time to learn about the risk and how to avoid it. If you cannot make the lunch, but would like to talk specifically about your situation, give Kim or Charity a call to set up a time. Either way, you can reach us by calling 731-285-0097. I will release more information on the lunch and learn soon.
If you follow these five steps and not your emotions, you will not lose sleep at night after listening to one of the business channels on TV or checking your account balance. As I mentioned in my blog from February, “the market will go down”. The real question is when and for how long. And the truth is, no one, not even the best money managers in the world can know. With that said, manage what you can!
If you would like help with any of this, a review of your holdings or even a stress test of your current allocation using the historical data of your investments, give us a call to set an appointment.
Lastly, A recent blog post I made titled, "The Market Will Go Down" may help you in these volatile times as well. CLICK HERE to read it.
Until next time… Cheers!
