08 Mar 2013 What Do We Do Now?
Today’s jobs report is lifting stocks to new heights. The Dow Jones Industrial Index crossed its historic high on March 5th and is now 200 points, or 1.4% beyond its high last reached in October of 2007. The total US Stock market as measured by the Vanguard Total Market Index is 2.3% above its October record and crossed that mark on February 8th. The S&P 500 has just under 2% to go before it makes a new high.
With all the talk of new highs there’s a lot of buzz about what to do? Is it time to get out or time to join the party, or does it matter? For those who believe that history has something to say about future movements, the question is a timely one. The chart below indicates that the S&P 500 has failed twice before to punch through current levels.
Do the peaks above represent some kind of enduring limit, or will the third time be the charm and vault us to dizzying new heights? If your portfolio is designed to ride the kind of volatility pictured above, (i.e. mostly stocks) then you might understandably feel a bit like the child on the bike who is about to experience the thrill (or terror) of a lifetime.
The image to the left presents a graphic example of how too many people perceive the stock market and investing overall. Its why 3% annuities and 1/2% bank CD’s continue to attract billions of dollars. Its why so many people are asking the question today – what should we do?
If you feel like the girl on the bike about now, whether exhilarated or terrified, you should consider a change. NOT because you may be in for a huge drop or continued new highs, but because you are almost certainly on the wrong path. Consider a path that is more directional and less up and down.
So why do we stay on the roller coaster? It is said that 80% of our decisions are based on emotions. To carry our metaphor into investing; we spend 80% of our time and energy on the emotional ups and downs and less than 20% on the logical direction of our journey. Who doesn’t enjoy watching stocks rise in value, the faster the better right? In fact most of us enjoy it so much we rarely count the cost our emotionally-driven strategy might have on the quality of our life’s path.
Study after study shows that investors’ decisions are predominantly based on emotions. Dalbar’s ongoing analysis of investor behavior most recently revealed that for the past 20 years ended 12/31/2011, individual stock investors received average annual returns of 3.49%, compared to a 7.81% return for the S&P 500. That’s a full 4.32% lost because of behavioral mistakes – decisions driven by emotion rather than logic. To put the difference in real life terms: An investor starting 20 years ago with $100,000 who added $5,000 each year sacrificed $387,000 in wealth because of his behavioral mistakes!!! Is this the right path?
So how do we flip the 80/20 dynamics to make them work for us and put us on a better path? How do we put the 20% logic in the driver’s seat and control the 80% emotion from ruining our ride? The answer is to change the path. Emotion and logic are part of our being. We cannot change that. But we can introduce discipline and process designed to champion and channel the best of both.
What if instead of worrying so much about the inevitable ups and downs of markets and economies, we more constructively focus our energies and emotions toward great purpose – our hopes, dreams and goals? After all, it is the way great things have always been accomplished by great people. They didn’t just happen by accident, they happened because emotional people made decisions to logically discipline their passions and emotions to rise above the status quo and conventional wisdom.
You too can accomplish far greater things focusing your energy and attention on your purposes, and allow us to help you with the process. The figure below represents a fundamental tool we use in the Wealthcare process that simultaneously illustrates the direction your path should follow in terms of wealth (on the left) for every year (on the bottom) of your remaining life and where you are in the journey. The path is bounded by a range of statistical confidence between 75% on the bottom and 90% at the top.
When the market’s ups and downs pull the path out from under your bike, we will call to get you back on the path. If you land in the blue, you will have opportunities to meet goals sooner or bigger, or to save less or take less risk or a combination. If you land in the red, we will advise you to make adjustments that are sensitive to your priorities: for instance you may want to save a little more, move a less important goal out or reduce it, work a year or two more, take a little more risk or some combination. The point is, we will make sure you stay on track while continuing to enjoy the ride along the way.
With your attention and energy focused on enjoying today’s ride and occasionally setting new goals and stretching existing ones, we’ll focus on making sure the inevitable ups and downs don’t diminish your confidence of meeting or exceeding every goal you value. You will experience the thrills of meeting and exceeding goals instead of the fleeting thrills of rising stocks. And because we will advise you to take no more risk than is absolutely necessary to meet your goals, the downs you suffer will likely be less severe than traditional approaches to investing. Doesn’t this sound like a better path?