I just listened to a podcast from financial author Larry Swedroe in an address to independent advisors around the country. I agree with his thoughts, and I thought it would be of interest to you to hear my summary of them.
First off, as we all may be aware, markets hate uncertainty and unpredictable events such as natural disasters, military conflicts, financial crises and political chaos. The world is a very risky place as it is, but when uncertainty is higher than normal there is the potential for the markets to grow very jittery.
The primary danger to investors is reacting to such events after the fact, or even as they appear to be occurring. When markets drop due to uncertainty, this can lead to a situation where institutions and individuals face liquidity problems that force them to sell positions. Margin calls and mutual fund redemptions caused by investors redeeming their shares are examples. When these events take place, the market can decline sharply. As the market declines the situation is exacerbated by many people around the world also selling shares in an effort to avoid further losses. Thus a panic can, and sometimes does occur, and sellers end up liquidating at just the wrong time.
Markets already incorporate all of the knowledge that is publicly known. So, current valuations already reflect the possibility, and perhaps anticipation, of future events. An investor considering selling must ask, “What do I know that the market does not know?” Think, if this high level of uncertainty didn’t exist, where would the market be? Naturally it would be higher. Price/earning ratios and corporate earnings remain at attractive levels. So, logically, when the crisis/uncertainty passes, one can expect the markets to recover. If you sell during the crisis, you’re likely worse off. Markets are already down because of the problems. As mentioned in the previous post Stock Returns Versus the Economy – The Disconnect, no one was predicting the growth in the markets that we have seen in the last year.
Yet there are some things you can do, and that we already have done. As Dwight D. Eisenhower once said, “Plans are nothing, planning is everything.”
First and foremost is broad diversification. As a side note; our portfolios are broadly diversified in large and small companies in the US and around the world. Each of our equity portfolios contain a 40% allocation to developed and emerging international markets.
The other is liquidity. Having enough assets invested in a capital preservation strategy to weather any temporary downturns we may face. Another side note; we use high quality, short-term bonds and cash for clients that need to withdraw money from their portfolios in the near term.
This leads to the final thought in terms of preparation; have a game plan. It’s extremely important to do the proper planning to know how much money you may need to invest in short- versus long-term assets. With this knowledge you can be best prepared ahead of time for temporary declines.
Of course we hope we’ll see action — and soon — that will ultimately be positive in the long-term. Any disruption in the markets will place more urgency on the effort to come to a potential solution that will be beneficial for our country and investors around the world. Though I must admit, it is very frustrating to witness the political process and the lack of resolution well ahead of the deadlines. Resolution of any kind very well could lead to a sharp rise in the market.
Crises will come, we don’t know when, how long or how deep, but we do know they will come. That’s why we, like Eisenhower, focus on planning and long-term outlook, so that when the battle comes, we’re already prepared.
If you would like to discuss your plan and allocation please contact me anytime.