March Madness is upon us and we have already seen many underdogs coming out of nowhere to upset the perennial powerhouse college basketball programs. If you filled out a bracket, like many of our clients in our annual Oak Street Advisor's Bracket Challenge, then I'm sure you've been somewhat frustrated with this year's tournament, as it has been chaotic and more unpredictable than in many years in recent memory. Just like this crazy tournament, the stock market can sometimes feel chaotic and unpredictable. Remember in January when some pundits were claiming another global financial meltdown was fast approaching as stocks slid lower and lower almost every day? The S&P 500 has now increased by 13% in the 5 weeks since the year's low on February 11th. Which actually puts the market UP for 2016. So just as we understand that each year during March Madness there will be chaos and unpredictability, we must keep the same mindset when it comes to our investments. No one can predict what will happen in the future, but we can certainly count on it being unpredictable, and sometimes chaotic. If you think risk is the chance your investment dollar will go down today, then I challenge you to ask the question “When should I take on risk?” If you choose to put your money in a CD or savings account, you avoid the risk of any fluctuation of the principle. You do have the risk of interest rates. Will they be higher or lower a year from now? Five years from now? Twenty years from now? Your answer is as good as mine. If you choose to instead invest in the ownership of great companies who provide great products and services to the world’s population, you have a very real risk that your investment could decline tomorrow. But what about a year from now? Five years from now? Twenty years from now? You can take risk now, or you can take risk later. The choice is yours. Today, we celebrate St. Patrick's Day in honor of the death of St. Patrick and Irish history and culture. There will be green everywhere, representing good luck, even in the many beers to be consumed today. One thing that we also hope to be green is our stock symbols. However, when it comes to good financial standing, there is very little luck involved. Diversification, strategy, and good habits produce earnings and security in your portfolio. While there may be times when you get financially lucky, say, winning the lottery or a windfall of money from a little known distant uncle, you shouldn't count on this luck- you should bank on a comprehensive and thorough financial plan to get you to the end of the retirement rainbow. Boring, boring, boring. That’s how you might describe one of the best investments my kids will ever profit from. Back in 1990 my children’s grandparents bought them 50 shares of Disney common stock for around $500 per child. The kids received the dividend check each quarter and thought it was neat getting a little extra allowance every now and then. It was something they never gave much thought to. Now that boring Disney stock has grown to over $5,000 in value for each grandchild. Suddenly it’s not so boring anymore. No glitz, not even one of the best performing companies over that time span, but the results speak for themselves. It is always amazing how stock market tops attract so many investor dollars. Just when things are at their riskiest point flows of funds into stocks skyrockets. We convince ourselves that the part will last forever and we hate being left out. The flip side is the head scratcher of a down market, where no one wants to buy even though prices are marked down 10%, 25% or even 50% on rare occasions. If this were a department store the aisle would be overflowing with bargain hunters. Yet when it comes to investments no one wants to shop the markdown rack. If you are feeling confident you should stop and think deeply about why. If you are feeling scared, then it is likely time to go shopping. Duration has a special meaning in the investment world. It is a measure of interest rate sensitivity in bond portfolios. You can calculate the duration for an individual bond or for a portfolio of individual bonds and you can derive an average duration. Why is this important? Because in a rising rate environment, like the one we are just entering, the duration will give you an idea of how much your principle will decline for a given increase in interest rates.
If your bond portfolio or your bond fund has an average duration of 6 years then you can expect the value of the portfolio to drop by about 6% for every 1% increase in interest rates. The Pimco Total Return Bond Fund with assets of around $246 billion dollars is one of the largest bond mutual funds in the United States. With an average duration of 5.26 years you could expect about a 5% drop in the funds value if interest rates rose by 1 percentage point. Or you could expect a 1.25% drop in value if interest rates rose by just 0.25%. Given that most bond funds have a yield of around 3% you can see that even small changes in interest rates can wipe out months of dividend income. So you should be aware of the duration of any bonds or bond mutual funds you own. Then ask yourself if the risk is worth the reward at this point CNBC was on in the background, I wasn’t really paying attention, but then I heard it.
“No bear market has ever occurred in the US stock market without a recession” There it was a blinding insight into the obvious. Who was that masked man? I may never know. He was gone before I could focus my attention, but he left behind something so true it forced me to rethink all the fears that market corrections cause. If you want proof then you can follow this link to a chart that is easy to understand. There has been one exception: October of 1987’s infamous Black Monday when the Dow plunged 22% in one day. Could we have another day like that? Maybe, but remember the Dow closed that day at 1,738.74. The Dow closed at 16,102.38 on 9/4/2015. The moral of this story is sometimes we get so caught up in the day to day worries of markets and headlines that the obvious is often overlooked. It’s obvious that equity markets go down. It’s obvious that markets don’t stay down. It’s obvious we are fearful and it’s obvious we should be bold. It’s obvious we should have a long term view of our investments yet it’s obvious we succumb to short term fears. Is today the perfect time to invest in stocks for the long term? Maybe, history shows that the price of the permanent ups in the market is making it through the temporary downs. No matter what happens in China, we will still be drinking tea from Nestle’, driving cars made by GM on tires manufactured by Goodyear, with gas purchased from Exxon.
I remember a story from early in my career, maybe it’s true, maybe it is a parable but it certainly is appropriate to remember when the stock market is in a panic mode. The story goes that a very smart advisor would tell each of the investors who opened an account with her the following: Mr. and Mrs. Smith, today we begin a long journey to build your financial future. Everyone is happy and optimistic as we begin to build your wealth for the long term. We have built your financial plan and today we begin to implement that plan. All is sunny skies and smooth waters. But, the day will come when the markets turn down and you begin to second guess all the work we have done. You will forget about the long term and focus on the short term turmoil in the markets. You will be scared, you will think me to be an idiot. You will want to come to my office and throw a brick though my window. And that is okay. If it will make you feel better please do it. I will even give you the brick to throw. But, when you have that brick in your hand. When you have taken aim, when your arm is cocked and ready to fling that brick, STOP! Write a check to add money to your investment account and tie it to the brick. Then you can throw it. Because that, my friends, will be the perfect time to invest! With the recent turmoil in the stock, bond, and real estate markets it is a good time to review one of the most important tenets of successful investing; minimizing your losses.
The math of losses works in a funny way. If you lose 10% on your investment, a 10% gain does not make you even. It takes a little over 11% to be even. If you lose 20% it takes a 25% gain just to be even, and if you lose 50% it takes a 100% gain just to get back to even. That's why you should have a strategy to protect yourself when things inevitably go wrong. 10%-15% gains in the stock market come along fairly frequently, but 25% plus gains are very rare. If you can implement a disciplined strategy to protect yourself from large losses you can be ahead while everyone else is still working to make it back to even. With the recent turmoil in the stock, bond, and real estate markets it is a good time to review one of the most important tenets of successful investing; minimizing your losses.
The math of losses works in a funny way. If you lose 10% on your investment, a 10% gain does not make you even. It takes a little over 11% to be even. If you lose 20% it takes a 25% gain just to be even, and if you lose 50% it takes a 100% gain just to get back to even. That's why you should have a strategy to protect yourself when things inevitably go wrong. 10%-15% gains in the stock market come along fairly frequently, but 25% plus gains are very rare. If you can implement a disciplined strategy to protect yourself from large losses you can be ahead while everyone else is still working to make it back to even. |
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