The stock market has been very good to us for at least a decade. Markets are cyclical. They go down from time to time. This may come as a shock to some clients and advisors.
Do you remember the Crash of 1987? Let’s put that into perspective: Client under the age of 33 weren’t even born in 1987! The dot com crash? That was 20 years ago. Some will remember the Great Recession.
Here’s an example of a potential problem: I started in the business in 1980. (That’s not the problem.) During the 1980’s there was an influx of Eastern Europeans coming to the US. Many settled in the New York area. Coming from a world where high inflation was normal, some assumed the stock market worked the same way. Everything went up. The difference was how fast! The stock market doesn’t work that way.
Eight Lessons to Remember
Here are a few things clients should remember.
- Markets are cyclical. Stocks go up. They go down. This can work out OK if your holding period is very long term. The Ibbotson mountain chart tells that story. The problem is the length of the cycles. That’s the piece of data we don’t have ahead of time.
- Sector rotation. Stock market indexes like the S&P 500 are composed of sectors. If the overall index is down by 10%, that doesn’t mean every stock is down 10%. Different sectors deliver different returns. Money can be flowing out of one sector into another.
- Asset allocation matters. Clients might think “bonds are boring.” This can be true when interest rates are low. Spreading your money across the asset classes of stocks, bonds and cash can lessen the risk. If the stock market was down 10% and the bond market was stable, the client loses less compared to being 100% invested in equities. Asset allocation might lessen risk, but it doesn’t remove risk entirely.
- Elevators and escalators. It’s often been said the stock market “Goes up like an escalator and down like an elevator.” Let’s hope they don’t learn this the hard way.
- Hold your winners, sell your losers. People sometimes say “No one ever went broke taking a profit.” It’s tempting. Consider another expression: “If you had a race horse and it was winning races, would you shoot it?” The logic is to let your winners run and sell your losers.
- It’s harder to make up losses than you think. It’s important to think in percentages. If a $ 100.00 stock declines to $66.00, it has lost about a third of it’s value. A $ 66.00 stock must appreciate 50% to return to $100.00. (Actually , it need to grow slightly more than 50%). 50% is a big move to expect.
- Selling your winners can leave you with losers. Clients often like taking profits, but are reluctant to admit mistakes and sell their losers. Suppose a client owned five stocks. Four worked out, one didn’t. They sold the four winners and bought four others. Three worked out, one didn’t. They sold the three winners and bought three different stocks. Two of the new ones worked out. They sold them and bought two replacements. One of those two worked out. The client is now holding four losers and one winner. How much have they lost on the losers in the meantime?
- Advice has value. If investing was easy, everyone would be rich. It isn’t. They aren’t. It’s important for investors, especially ones who haven’t seen a down market before to have a steadying influence to advise them. That’s you. Advice has value.
Let’s hope we don’t see a down market anytime soon. Just be aware one is out there.