It was nice while it lasted. The S & P 500 (total return) Index fell .75%, its first quarterly loss since the third quarter of 2015. Some asset classes, of course, fared a bit better, with the small-cap Russell 2000 Index down .08%. The MSCI Emerging Markets Index gained 1.42%. Others performed worse. The MSCI World (ex USA) Index fell 2.04%. Real estate was the worst performer, with the Dow Jones US Select REIT Index falling 7.43%.
And your bond allocations didn’t help. With interest rates rising by 25 – 35 basis points, the Barclays US Aggregate Bond Index fell by 1.46%.
Volatility returned with a vengeance. During the quarter the S & P 500 Index experienced 23 days with a 1% move, almost double the historical quarterly average and triple the number of such swings in all of last year. During the first week of February, the market fell by 6%. In the middle of February, we fretted through several days of negative 2 – 4% drops. In the context of the post-2009 recovery — and the especially calm 2017 — this felt particularly unpleasant. In fact, a couple of leveraged funds whose charters were to bet on continued low volatility went out of business during this period.
And the volatility didn’t stop in the first quarter. On fears of a trade war with China–that may or may not actually occur – (as well as the continued focus on Facebook’s privacy policies) the S & P closed a volatile first week of April down another 1%, following several wild intraday turnarounds.
Actually there are typically a good number of 2% or greater declines during any given year. And markets experience modest – and sometimes substantial — peak-to-trough losses every year. But critically, there is no discernible pattern for annual returns based on how the market performs at any point in the year. In the short and intermediate term returns are entirely random.
With the return of rough seas, it’s good to remind ourselves of how to manage our investments–and the related emotions – in order to safely arrive at the various ports along the way.
First, you must have a realistic destination and a plan to get there. Know that the weather, just like the investment climate, is going to change frequently. Incorporate the ability to make mid-course corrections; such as working a bit longer and spending a bit less on luxuries. Well thought out plans almost never fail completely. But rather are able to get back on course with modest adjustments.
Not only must we navigate the squalls of daily volatility — like we’re experienced so far this year — but also the more prolonged storms of bear markets. Since 1980 there have been 11 “corrections” of 10% or more and 8 “bear markets” – declines of 20% or more lasting at least two months. The average intra-year decline was about 14%. But calendar year returns were positive in 33 of 39 of those years. And the annualized compound return during this period has been 9.81%. These gyrations can’t be timed by tacking in and out of the market. One reason is that the best and the worst trading days frequently happen within days of one another.
We’ve all heard the old aphorism that diversification is the only free lunch in investing. But there are some reservations.
The main feature of diversification is that generally not all asset classes perform poorly – or well – simultaneously. But having a diversified portfolio introduces a crucial behavioral challenge: choosing the right benchmark. A multi-asset class portfolio is going to march to its own drummer. It will never, in retrospect, have been the best thing to have been invested in. So a standard benchmark, like the S & P 500 is not going to be correct. Far better to have your own personal benchmark: perhaps the growth rate or wealth level you need to achieve your own personal goals.
It also helps to know some history. The attached chart shows the 1-year, 3-year and 5-year performance of a balanced (60% stocks, 40% bonds) strategy following six crises over the last 30 years. As you can see, the cumulative total return after five years was 50% or greater in every instance.
There is no substitute for having a well thought out plan –taking into account your goals, risk tolerance and time horizon –and sticking to it. By definition, this is a two-part strategy. First, having the plan. And then employing whatever tools, tricks and coaching you have at your disposal to maintain the discipline to carry it out.