When I was a freshman in high school, I decided to play football with the 9th grade team. I’ll admit now that I was doing it for personal reasons–several of the basketball coaches also coached 9th grade football. I loved football, but basketball was my true love.
Football, however, was somewhat an expectation if you were an athlete because you see, football is a bit like a religious denomination in my hometown. I know that many places are quick to point out their affinity for football. Yet, our town is actually nicknamed “Football City, USA.”
That’s right. Rock Hill, SC has produced more NFL players than any other town in the United States. At least, that’s what the people who check on statistics like that are saying. If you live here, though, it rings true.
Our 9th grade football team that year was no ordinary team. During 8th grade, this team was undefeated, and they did not allow a single score all year. I’m sure you’ve heard of teams that go undefeated. But, have you ever heard of a team that plays all season and gives up zero points?
One thing about football that you learn very quickly is that, to the extent possible, football coaches make it a year round activity. No, you can’t be in pads or have formal practices all year, but that’s not an issue. There’s always something you can be doing.
One of my most vivid memories from football is the summertime workouts. These were “conditioning” workouts designed to get our bodies in shape for the upcoming 2x / day practice schedule. You know–the beatings to get ready for the other beatings.
These workouts were brutal. Our coaches would gather the entire football program into a small gym. Let’s call it the furnace (you can imagine why). During the thick summer heat in the South, we’d run drills for the next 2 hours.
My mentals screamed at me the entire time to make the pain stop. You’d be surprised how loud that inner voice can get when all of your muscle groups are on fire, and your lungs cannot seem to get enough oxygen. All of your teammates look just as ready to throw in the towel.
But, then it happened.
Your favorite coach would give you an approving nod. Teammates began encouraging one another, and you realized that you weren’t going to die. You were going to keep going, and before you knew it, it was over.
Check the box–another workout complete.
Embracing the Grind
For many investors, it feels like we are in the furnace right now. Inflation is raging. Stocks have moved into a bear market, and we are hearing whispers of a recession.
Our inner voices are screaming at us to do something– anything– to make the pain stop. Our human reflex to dump our assets kicks in, and our brains go to work on finding evidence to confirm that choice. It feels like the only rational choice, right?
We talk to friends and neighbors who are just as scared as we are. Then we turn on cable news just in time to catch the evening special with “Markets In Turmoil” flashing on the chyron. Capitulation is on the menu.
It’s time to duck and cover. At least, that’s what some want to do. This is the time when I remind you that capitulation is a choice, not a mandate for times like these.
One of the most important components of being a financial advisor is very similar to being a coach. I use “coach” from time to time, but I have grown to prefer “guide.” Coaches don’t get on the field, but guides are with you on the journey.
Therefore, as your financial guide, I want to share some insights with you. My hope is that these bits of information will reorient your frame of reference and bolster your resilience. Let’s take a look at some visuals, shall we?
Investor Fuel for Bear Markets
This first chart comes from JP Morgan’s Guide to Markets, and it shows us the calendar year returns of the S&P 500 vs. the intra-year declines. Many people have grown to feel that sloshy markets are an aberration. Look at how many calendar years end with positive returns, despite having some intra-year volatility.
In my opinion, the next chart cannot be underweighted in your mental investing notebook. This graphic shows the rolling returns for various periods of time. Very few investors have a short time horizon, even ones that believe they do.
What many of us investors do have is recency bias, which is when we give greater importance to recent events versus historical ones. When every news station is talking about inflation and the potential for economic recession, it can be very easy to succumb to recency bias and our emotions. Fight this urge. Fight it with all you’ve got.
The first part of this chart, showing the 1 / 3 / 5 year periods, can yield some results that may be disappointing. These are rolling returns, so current events and your inception point may have a disproportionate impact on results. However, if we zoom out to a 10-year or 20-year period, probabilities improve significantly.
Investors and Recency Bias
Let’s dig a little deeper into recency bias. In about 10 days, the GDP numbers for Q2 2022 will be released. It’s highly likely that these numbers will confirm what many of us already feel to be true—that the US economy is technically in a recession.
The current projection from the Atlanta Fed GDPNow is -1.6 percent growth in Q2. If this prediction holds, there will be nonstop news coverage talking about recession. I fully expect the financial media to devote themselves to driving fear, uncertainty, and doubt into the hearts of investors.
Knowing this is likely to happen, I would be doing you a disservice if I failed to show you this next chart. Recessions can be scary, but they are part of the economic cycle. Market rebounds can be profitable for those who remain in the game.
Remaining in the game is tough. But, that’s our calling as investors. If your goals include maintaining purchasing power, preserving lifestyle in retirement, building wealth, or transferring wealth–I know of no other prescription than being an unwavering investor.
“But, what if I just hop out? You know, just hit the sidelines. I’ll get back in the game down the road when things clear up.”
Many of us are tempted to fall victim to this siren song. Even professional investors are often tempted to abandon their strategies during tough periods. We are humans, and we suffer bouts of recency bias as well.
Market timing is one way that our recency bias comes for us. Safe harbors call out to investors and tell us that we can avoid all of the mental anguish. Trying to time markets may provide immediate peace of mind, but it often proves to be a horrific mistake.
Don’t take my word for it– it’s just math. The next chart illustrates the potent impact of missing special upside days in the market. As you can see, those few moments on the sidelines can truly decimate investors and their returns.
Inflation: A Real Enemy
“Well, what about inflation? How are we going to deal with that?”
Like many financial professionals, I’ve had to dust off the inflation playbook. We’ve had such a long run of low inflation that we were actually beginning to warn investors of the potential for deflation! All of that changed as we came out of the COVID pandemic.
Our politicians in DC discovered that people actually really, really, really like getting money from the government. Shutting down the economy and giving people money was an interesting attempt at governance in 2020 and 2021. But, that’s what our leaders did.
Massive amounts of money was created, and our M2 (money supply) skyrocketed. Unlike the crisis in 2008, we gave money directly to people this time around. And, people spent it.
Milton Friedman wasn’t joking when he said, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”
I now believe that we may see inflation stick around longer than anyone desires. However, there’s no real way of quelling the current inflation numbers until consumers stop spending and demand is sufficiently diminished. Many people think the Fed can do this… but I have yet to read any research that explains how rising interest rates will lower gas prices or make food more affordable.
So, what can we do?
First, understand that inflation is highly personal. If you have a low interest rate on your mortgage or own your home, you’re not exposed to the higher rates or increasing rents (though a cash out refi may not be a good idea right now). Households that drive very little and eat their meals at home will have a different experience with inflation than households that have long commutes and constantly eat out at restaurants.
Take a moment and look at how you are actually being impacted by inflation. You may want to consider making some adjustments if necessary. One adjustment I would not propose would be to abandon your long-term investment plan.
The following chart shows the real price return of the S&P 500 vs. the purchasing power of the US dollar. Here we can see the nefarious nature of inflation when it comes to wealth. However, it does appear that one way investors can truly seek to preserve purchasing power is to remain invested in growth assets.
Investors, Sequence Risk, and Retirement
Let’s take a moment and check-in. How’s this landing for you? In a struggle between emotions and data, I’ll confess to you that emotions often win.
My hope is that I’m planting enough seeds of optimism that you can hang in there for one more week…which becomes one more month… which becomes one more quarter. You get the idea.
I’ll conclude with a more concrete discussion on how this investing framework plays out in real life, especially with pre-retirees and retirees. Retirees and pre-retirees do need to be more mindful of downside market risk. This article is by no means a dismissal of the very real fear of market declines.
Taking large market losses in the portfolio that you plan to use for retirement income distribution can give you massive heartburn. It also can significantly impact the viability of your retirement income plan. Again, that’s just math.
Our retirement philosophy addresses this acute market risk head on. One of the first things we seek to learn is the true cost of your lifestyle. Next we assess the cost of preserving that lifestyle. Then we divide and conquer.
We believe that retirees should have assets that are dedicated to income and assets that are dedicated to long-term growth. You may have heard the phrase “put your money to work.” Well, we do just that—except we don’t forget to leave out the actual job description.
Too many people attempt retirement with a FrankenFolio– a monster portfolio that they hope will be all things at all times. They consult with Google (bad). They talk with neighbors (worse). Some are even tempted to retire with no formal plan (worst).
We believe there is a better way.
For the clients that work with our team, this is why we go through our retirement income design process. We find the assets that need to be dedicated for income and lifestyle preservation, and we position them accordingly. That frees up other assets to truly become growth assets.
During market declines, it can be very tempting to dump our portfolios and head for shelter. It can also be tempted to stop living your life because the fear of running out of money takes hold. This is human nature.
Even the best financial advisors have tough days dealing with our emotions. Remember–the guide goes on the journey with you! Want to know what we do?
We review our own financial plans. We have conversations with other professionals that can offer a word of encouragement or help us get refocused. We turn off the negative tv, social media, and neighbors.
There will always be reasons to sell. When markets get choppy, we often seek out those reasons (confirmation bias). Just remember:
● Building wealth requires discipline and a long-term mindset.
● Preserving wealth requires assets that can outpace inflation over the long term.
● Retirement can last 20-30 years after you reach age 65
As always, our team is here for you. If you have questions or concerns, please don’t hesitate to reach out. We are on this journey with you. Be encouraged and stay the course!