We have seen that there are some pretty good arguments that the future of stock and bond returns will be less than they have been in the recent past. I want to make a point to say that these predictions are anything but set in stone. Nobody can predict the future; however, it would be irresponsible to ignore these findings. The question then becomes what to do about it.
Resist the urge
You have probably heard the Wall Street mantra being spouted these days that the buy-and-hold strategy is dead. They think their stock picking/option trading/market timing strategy will help you “beat the market”. The problem, of course, is these marketing campaigns are meant to transfer money from your pocket to theirs.
On its own, buy-and-hold is a poor strategy. A better strategy is buy, hold and rebalance. Even that can be improved, but I will leave it to another post. The point is that actively trading in the market to try and juice returns will most likely end badly for you. It has been widely studied that it is very hard to consistently beat the market beyond what is randomly expected. The best bet is to control what you can and alleviate as much risk through diversification.
Saving and Spending
While we can’t control market returns, we can control how much we save and spend. When you are planning for long-term needs make sure you, or your advisor, is using realistic assumptions about future returns. As I have stated I believe these numbers should be below what the historical data will tell you.
Using these revised assumptions will most likely lead you to adjust your plan to some new combination of reduced spending and increased savings. It could end up that we have a great 30 years of returns and you end up with too much money. A problem I think most people wouldn’t mind too much.
I see clients with multiple security holdings who think they are diversified, but in reality they are far from it. Holding 50 different US large cap stocks hardly makes you diversified. We typically build portfolios for clients that hold over 5000 stocks. The number of stocks only gets you part of the way there, however. You should gain exposure to US, international and emerging market stocks. Other asset classes like REIT’s and commodity futures also deserve attention. Bond holdings should be both from US and international issuers. International bonds can be selectively hedged in some circumstances to boost total returns.
Besides asset class diversification you should diversify the drivers of returns known as risk premiums or style premiums. If you hold a total US stock market ETF like Vanguard’s VTI you have diversified away all of your unsystematic risk, but you only have one driver of return, the equity premium. Academic research has discovered multiple other style premiums such as small, value, momentum and profitability (I will profile each of these in the coming weeks). These style premiums should be applied to both US and international stocks.
The Behavior Gap and Market Timing
It is well documented that we as investors are our own worst enemy. Carl Richards wrote a great book called “The Behavior Gap.” It is full of great information for all investors. A key theme in the book is that most investors that try to time the market underperform. If you invested $1,000 in the S&P 500 in 1970 and didn’t touch it until the end of 2012 you would have $58,769. If you missed just the 5 best days of the market during this time you would only have $38,212. Many “market-timers” tend to sell at lows and buy at highs – imagine losing out on $20,000 because of bad timing. Some of the best days of the stock market occur right after a large decline. Waiting for the “All Clear” signal before re-entering the market will only cost you money in the long run. It is best to not try to time the market, but to stick to a well thought out plan, especially during periods of market stress.
This is far from a complete list of strategies to guide your wealth management strategy. Other basic tenets of a comprehensive investment plan include tax efficiency, smart rebalancing and low management costs. These will serve you well in any market, but even more so during periods of low market returns.