Barron’s magazine had a December 28th article that talked about “The five days that killed the year.” The article pointed out five trading days that were accountable for 95% of the losses in the S&P in 2022, a year we would all like to forget. The losses ranged from -3.6% to -4.3%. This article is filled with information, but it is the dietary equivalent of empty calories. Here’s why: the five best days of the year returned between 2.99% and 5.54%. The five best days would have virtually negated the five worst days and you couldn’t have done anything about either.
There are better things to observe than being in or out of the market.
2022 was one of the worst three years in history for a traditional 60% stock/40% bond portfolio. The other two were during the depression. Even 2008 was a better year for that type of allocation. Bonds collapsed as interest rates rose and stocks fared worse. But if you are a retiree, for example, it has become easier to hit your spending targets. If you want to spend 4 percent of your portfolio, heck, bonds are paying over 4 percent now. Owning only bonds is a bad strategy, though, because you won’t have inflation protection. Remember, volatility is your short-term enemy while inflation is your long-term one. So if you went back to the 60% stock, 40% bond portfolio, the stocks don’t need to work as hard as they did a year ago and they are less expensive. This means that their expected future returns are higher.
If you are a saver, then market disruptions make your balance sheet worse, but they make your monthly saving more productive. If you are buying mutual funds each month in your 401(k), you are buying 15 to 20 percent more shares each month than you were a year ago. The best thing that can happen for longer-term investors is for the market to stink for all the years they are accumulating and then turn around close to the time they need the money. Focus on the number of shares rather than the value of the account.
Another thing to look at is what your various time horizons are. We all have multiple targets. Money that you need in two to three years is ideally in cash (now earning close to 4 percent!). But longer term money should be invested in a combination of stocks and bonds. One time horizon may be when you need to begin withdrawing from your portfolio for education or retirement costs. A different one may be when you are saving for something to buy in the future. A third one is if you are fortunate enough to have money that you want to leave after your passing for your kids or charity. All of these time horizons may have different objectives. That’s why the old adage of owning 100 minus your age in bonds is silly.
As you have identified these various events, then you should set up an investment allocation that is appropriate for your risk tolerance (how well you sleep at night) and your risk capacity (how much you can lose without forcing yourself to make drastic changes). Diversification creates predictable, but not maximum returns. Elon Musk didn’t get rich selling Tesla and buying mutual funds, but he also, according to Forbes, has recently seen $200 billion of his net worth evaporate. For most of us, systematic savings and diversification are the best way to provide the money we want to spend when we want to spend it. Diversification means owning investments that behave differently. Over the last 10 years, owning an index fund mirroring the S&P 500 served investors well, but that is partly because how poorly that investment did in the ten years prior. Last year, an international index fund would have outperformed the S&P. Investment asset classes may diverge wildly year by year and diversification captures the best and the worst each year resulting in more consistent returns over time. Over longer time horizons asset class divergence contracts.
Make 2023 a year where you focus on the things over which you can control and give you the best chance of success.