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Market Insight: Widen Your Aperture

Dylan Potter, CFP®, Vice President, Wealth Manager

Comfortable Being Uncomfortable

How will I behave in combat?

This a question I asked myself countless times before my first deployment to Afghanistan. As a young officer who performed well in training, I thought I had the foundation to do well, but there really isn’t a substitute for the real thing. Some things must be experienced before they are truly understood. A tough training scenario can recreate the sounds and chaos of combat, but it can’t recreate the emotions. No matter how stressful the training event, it’s still just that, a training event. There may be notional casualties, but actual Americans aren’t bleeding out, waiting on a delayed helicopter to arrive.

Over the course of my Army career, I helped train young Soldiers and Rangers. As I grew older and became more introspective, one common thread became apparent: there was no definitive indicator or personality type or physical attribute that would allude to combat performance. Soldiers come in all shapes and sizes. But as Mike Tyson said, “Everyone has a plan until they get punched in the mouth.” In other words, everyone imagines how they will behave when the bullets start flying, but it isn’t until that unforgiving minute that one’s true character comes out.

 

Some things must be experienced before they are truly understood.

Market volatility is the same way. Everyone reacts differently to market uncertainty. Like combat, there’s no defining characteristic that can pre-determine how one will behave when the indexes begin falling. It’s easy to examine the historical data and typical drawdowns. It’s much harder to be on the verge of retirement and physically feel the emotions associated with a rocky market. Will this thing ever come back? Is this the big one? No amount of financial planning or data analysis can recreate the angst and worry of seeing a portfolio go from $1 million to $800,000 in a matter of weeks. Just like in combat, it’s in these moments that true character emerges.As investors, we can study standard deviations and risk. We can model drawdowns and market corrections. Our flaw, however, is that as humans when we visualize stock market losses, we imagine ourselves in some hypothetical world where the only thing that has changed for the worse is the stock market. But stock market drawdowns do not exist in a vacuum. What we cannot visualize is the state of the world that causes that stock market downturn and how it feels to live through moments where the headlines are filled with World War III jargon, inflation, and civil unrest. It’s these emotions, and their control (or lack-there-of) that can lead us down the path of continued wealth creation or sudden destruction.

Over the long term, stock investors who stay the course are rewarded for it.

Missing the one best month during a year (due to selling to avoid further losses, let’s assume) drastically reduces returns for investors. To call upon some historical numbers, during years when returns were already negative, the effect of missing the best month only exaggerated the loss for the year. In seven of the 49 years from 1970-2019—1970, 1978, 1984, 1987, 1994, 2011, and 2015—otherwise positive returns would have been dragged into negative territory by missing the best month. The appeal of market-timing is obvious—improving portfolio returns by avoiding periods of poor performance. However, timing the market consistently is nearly impossible. And unsuccessful market-timing (the more likely result) of both getting out and getting back in can really hurt a portfolio.Investor Bill Miller echoes this point, “In the post-war period the U.S. stock market has gone up in around 70% of the years…Odds much less favorable than that have made casino owners very rich, yet most investors try to guess the 30% of the time stocks decline, or even worse spend time trying to surf, to no avail, the quarterly up and down waves in the market…We believe time, not timing, is the key to building wealth in the stock market.”The U.S. Aggregate Bond Index is down -10.1% YTD. 1931 is the only year in U.S. bond market history that even compares—that year it was down -9.1%. However, returns for the next five years following that year were, respectively: 16.2%, 7.4%, 13.4%, 8.9%, 8.2%. To illustrate this point further, let’s consider the chances of bonds staying negative for an extended period. Bonds were negative in 2021 and they’ve obviously started 2022 negative, as well. What are the chances of bonds being negative for a second or third year, historically speaking? Well, bonds have been negative two years in a row only twice in the past 90 years and never for three consecutive years. This is history we’re referencing, which is of course no guarantee for what we stand to witness. However, it’s the best guide we have, and it’s an important reminder of the light at the end of the tunnel.

It takes guts to be an optimist.

It also takes courage and rationality to remain calm during these chaotic and frightening times. Progress compounds slowly and to such an extent that we often barely notice it. Setbacks can be sharp and terrifying, yet somehow, we usually rebuild and the compounding of progress continues. With the choppiness of the stock and bond market, it may be tempting to just cut your losses and retreat. But don’t. Investing comes down to surviving an inevitable chain of short-term setbacks to enjoy long-term progress and compounding. Your portfolios are well diversified and invested in quality companies. In stressful situations, it helps to step back and detach. As the saying goes, “It’s hard to read the label when you are inside the bottle.” In investing, detaching means widening your aperture. Every valley and trough in the chart below felt awful in the moment, but somehow the march of progress and business ingenuity continued. Don’t bet against America. Keep moving forward. You’ll be okay.

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