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Don't Try, Know!

January 13, 2021
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The Future – What do you want it to be?

As I read through the numerous market forecasts for the year, it seems that the only certainty is that you can make a strong case for whatever you would like the future to be. If you’re hoping for a bull market with 10%+ returns, there are many possible ways or that to happen, not the least of which is TRILLIONS of taxpayer dollars being injected into the economy, extremely low interest rates which makes stocks look cheap compared to low yielding bonds, CDs, etc… If you’re concerned about the damage done to the economy because of the response to the COVID-19 outbreak, a US Government deficit of $3.3 trillion (3,300,000,000,000) dollars, a National Debt of $20.3 trillion dollars, unemployment levels at stubbornly high levels, very high stock prices, etc, then there is a sound case to be made that 2021 could see the stock markets fall. It is fascinating that people can look at the same data and draw opposing views of the outcome, but if that were not the case there would be no market. Investors purchase stock because they think that stock is more valuable than cash (or something else), at the same time that the seller of that stock thinks having cash (or something else) at that point is more valuable than owning the stock.

So, what do you do? Don’t TRY. KNOW!

Don’t Try.

That is, don’t TRY to guess where the markets are heading in the short term. It’s a fool’s errand. Forecasting the future entails consideration of multiple variables and their probabilities. At best, a forecast is a possible outcome with some assigned level of probability, or more likely, a range of possibilities. And unless the probability is 100% (which it never is) there is no certainty that it will occur as forecasted. There could be an 80% chance that the market will be up 10% by the end of 2021 which means that there is a 20% probability that it won’t. It’s the 20% that causes sleepless nights and upset stomachs.

Know. 

What you can KNOW is how much risk you are willing AND able to bear and what your target rate of return is to meet your investment goals. What do I mean by risk? In this case I am referring to how much of a loss you are willing to suffer at any point in time. Think about this. What would make you feel worse: 1) learning that your investment account was down 34% or 2) learning that you made only 5% when the overall stock market was up 15%? As you think about how you FEEL about that question, consider the following:

Here are 5 Asset Allocation Models and the S&P 500 Index and their performances over the past 20 years which included 3 recessions:

1/1/2000 through 12/31/2020



(Image: Perspective 1: Asset Allocation Models etc.)

Notice the difference between the Conservative Allocation versus the Aggressive Allocation.

(Image: Perspective 1: Conservative vs. Aggressive)

The Conservative Model achieved a return of 4.91% with a maximum drawdown of -8.03%, whereas the Aggressive Model achieved 6.41% and experienced a maximum drawdown of -50.98%.

Before you decide in your mind which of the models you would feel most comfortable with, let me add another perspective of the same facts. Assume the same information as above but view the outcomes as follows:

(Image: Perspective 2: Asset Allocation Models etc.)

Now look at the difference between Conservative and Aggressive:

(Image: Perspective 2: Conservative vs. Aggressive)

 Note: Achieving the difference assumes that you didn’t touch the money for the entire period

Know this, if your goal is to make as much money as possible, then your goal also includes the possibility that you’ll lose as much money as is possible (probable). Know that if you don’t want any risk of losing money, then you have to be fine with lower returns, which translates into less money being earned.

Knowing how much risk you are willing to stomach is different from knowing how much risk you are able (or need) to bear. Whereas the first is related to your comfort level, the second is tied to what level of return you need in order to achieve your financial goals (target rate of return.) Do you need 2%, 6%, 10%? This is mathematically determined based on how much money and time you have to reach your goal. 

One of the best ways to determine how much risk you can bear and what level of return you need is to develop a Financial Plan. We provide this service free of charge to our investment management clients. If you don’t have a written Financial Plan, I encourage you to click on the embedded link to begin creating yours today.

In summary, history tells us that stock markets go up and  down. Over the long term, they have gone up, and there is no reason to believe that the future will be any different. The key to navigating the uncertainties is to know what you can know (risk tolerance and target rate of return) and know what you can’t know (the short-term direction of the markets) and have a plan that incorporates both.  

Please let us know how we can be of help. Together, we know more than any one of us. I welcome your thoughts and comments. Best regards,

Lee

Important Disclosures:

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market, economic or political conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed. This content was created as of the specific date indicated and reflects the author’s views as of that date. Supporting documentation for any claims or statistical information is available upon request.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk including loss of principal.

Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. For more information on indexes please see www.schwab.com/indexdefinitions.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets. Investing in emerging markets may accentuate these risks.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk.

Diversification, asset allocation and rebalancing of a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.