Put market volatility in perspective
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The first quarter of 2022 has served as a stark reminder that financial markets can decline — and decline quickly.
With volatility largely driven by the Russian invasion of Ukraine, the markets have not reacted kindly to recent political instability, the expected effects of sanctions imposed on Russia, and the overall impact on global trade and economic growth.
Also affecting markets has been the heightened expectations of rising interest rates as the Federal Reserve tightens monetary policy. Fed policy is driven primarily by concerns about inflation. In December 2021, the Fed signaled it expected to raise interest rates several times in 2022 to cool down the economy and has thus far implemented one rate increase in March.
Declining markets are a normal part of investing. The relative frequency of these downturns makes them no less unnerving to the investors who see their financial security at stake when the market dips. However uncomfortable to endure, short-term market declines are not a threat to investors with a thoughtfully constructed portfolio that considers both their temperament and their financial ability to take on risk.
Instead, the true threat is failing to stay invested through these inevitable declines.
Staying on the ride
Roller coasters feel uncomfortable, but most passengers are perfectly safe while strapped in and riding out the sudden drops and curves. Only when a rider tries to disembark from a speeding coaster do they endanger themselves.
The same is true of investing. Yet many investors contemplate leaving the “ride” during a downward slope because they are haunted by the idea that they might have missed a sign that makes this dip different from all the others they have seen. The financial media makes matters worse, as news channels flip from interviewing experts explaining why the market will start going up to experts explaining why it will keep going down.
No one in the media will tell you (because it makes for boring television) that remaining disciplined can be the key to profitably riding out a downturn. What does that mean? It means not buying or selling anything without examining the underlying fundamentals, thinking about how each position is likely to move when the noise dies down, and considering the rich historical context of how downturns typically play out.
Wealthy history of downturns
It is easy to think of a downturn as nothing but bloodletting of principal and profits, but when you look at the data, you can see just how untrue that is. The S&P 500’s 15 best performance days between 1958 and 2020 did not happen during bull markets but during bear markets.
During some of the most significant dips in the past 60 years, many investors have given in to temptation, fleeing the markets to hunker down until a rebound. Yet, doing so takes them away from some of the best and most profitable days to be invested. In fact, these best 15 days took place during all our more recent financial crises, including the 2020 COVID crisis, the 2008 recession, the dotcom bubble and 1987’s Black Monday.
In marriage, spouses vow to remain dedicated to each other for better and for worse.
As investors, dedication to a well-planned portfolio during better and worse can be quite profitable. A $10,000 portfolio invested in the S&P 500 in 1950 would have grown to almost $700,000 by March 2020 if the investor missed only 10 of the best days during that time. One who stayed invested and rode out the downturns would have more than twice as much, reaching a portfolio value of $1.5 million in March 2020.
When reviewing the history of market drops, one will see the same fundamental pattern uniquely responsible for these better returns. Each begins with a drop that strikes fear in the hearts of investors, followed by a reversal, which brings in better returns.
How much of a drop should investors be comfortable with? And how often? Consider that since 1950, 10% or greater market drops average once per year. Bear markets, defined by a decline of 20% or more, happen every 6 to 7 years on average.
Avoid costly mistakes
Attempting to time the market to avoid bad days and take advantage of the good ones is practically impossible, especially for busy physicians who do not have time to obsess over moment-to-moment market movement. It can also be enormously costly, as investors who do this are likely to miss swings to the upside and, thus, create an untimely tax burden.
On average, the market rebounds 41% during the 12 months following a market bottom. Over the subsequent 5 years, the rebound generally reaches 93%.
These statistics highlight the point that selling after a decline effectively captures some or all of the downturn and misses the rebound — a sure recipe for failure. Instead, physicians should strive toward building a well-diversified portfolio designed to withstand downturns and aligned with their risk profile. Therein lies the foundation for a successful investment strategy.
For more information:
Wealth Planning for the Modern Physician and Wealth Management Made Simple are available free in print or by ebook download by texting HEALIO to 844-418-1212 or at www.ojmbookstore.com. Enter code HEALIO at checkout.
David B. Mandell, JD, MBA, is an attorney and founder of the wealth management firm OJM Group. He can be reached at mandell@ojmgroup.com or 877-656-4362. Bob Peelman is a partner and director of Wealth Advisors. You should seek professional tax and legal advice before implementing any strategy discussed herein.
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