Why do we plan a vacation? Many, if not most of us, lay out meticulous plans to ensure that our trip goes smoothly. Doing so enables us to do all the things we want to do and see all the things we want to see. But what would happen if we didn’t create a plan in advance? Might a relaxing vacation turn out not so relaxing? Might a potentially great experience turn into a frustratingly negative one? Don’t get me wrong, I know some folks live for spontaneous adventure, but I can’t imagine too many of us like to travel without some sort of plan. By setting an itinerary or planning ahead many of the main aspects of your trip, you can have your expectations become a reality and help to minimize most travel snafus. We plan because there are rewards for doing it.
Now let’s move this idea of planning into the world of financial planning, or investment planning – whichever. I jokingly say that I help people plan for the longest vacation of their life … their retirement. But it’s true. And with most clients, we lay out a pretty meticulous plan. Coincidently, it’s well known in the financial planning industry that most people actually spend more time planning for vacations then they do planning for their own retirement. That’s unfortunate. I’m in my early (cough cough) 40’s and if you think I’ve got great confidence in Social Security footing my bills in retirement, think again. You better believe I plan.
The first thing to do when laying out a financial plan or an investment plan is to know what things can derail your plan. Taking the time to understand the many things that are out of your control, can be time well spent. Here’s a sneak-peek: interest rates, inflation, the stock market, the Federal Reserve, the bond market, corporate earnings, corporate malfeasance, tax legislation, Washington D.C., terrorist attacks, natural disasters, the economy, housing prices, unemployment … ok, you get it. There just aren’t many things that you can control when investing, or even when planning for your retirement. There are so many variables and too many unknowns, but there is one thing you can control … and that’s you.
If we, as investors and intelligent individuals, can only control one thing and that being ourselves, then why does study after study show that the average investor has earned, over time, less than one-half of what the stock market has returned? It’s the old emotional rollercoaster that has one buying high (chasing returns) and selling low (hitting the panic button when the market gets ugly). The exact opposite of what we should all be doing. Why do we get emotional when the market goes down, or our plan veers off course temporarily? Worse, why do so many react to it when it does?
Here’s a statistic for you: since 1980, there have been 27 positive-return years and only 7 negative-return years in the S&P 500. So there are pretty good odds that the stock market, in any given year, will produce a positive return. But did you know that the average “intra-year” pullback during that same timeframe was 14.7%? It’s true. That means that during that same timeframe the stock market dropped, at some point during the year, on average 14.7% from a higher point. In fact there are more than a handful of years (6 to be exact) when the stock market was down more than double digits and rebounded to end up earning a positive return of over 20%.
Now I want to be very clear, in that same 34-year history we had ‘Big Nasty’ aka: Calendar Year 2008 “The Great Recession”, a year which the market had an intra-year pullback of 49% (the S&P 500 ended down 38% that year). Even if you exclude that monstrous year, the average intra-year pullback is still 13.5%. Interestingly enough, the term “market correction” is not officially used until the market drops 10% from its high. So if the average intra-year pullback is roughly 13%, then we have, on average, a “correction” at some point almost every single year. Hopefully knowing this will ease some concerns when the market gets choppy. Although I realize there will always be concerns because it wouldn’t worry anyone if we knew it was only going to go down 10-13% and then bounce back. It’s the fear of the unknown and another year like 2008.
Here’s my take on it, we need to welcome pullbacks. They make for a stronger market long term. Markets are healthiest when they make three-steps forward and one-step back. Last year we took ten steps forward and hardly leaned back let alone stepped back. The biggest pullback last year was only 5.6%. So shouldn’t we be due for a larger one given the historical averages? Again, the mistake that needs to be avoided is a knee-jerk reaction to it if it does. Have a plan laid out, and have some dry powder (cash) on the sideline to take advantage of it if it does.
I well recognize your own personal financial or investment planning shouldn’t be predicated on what the “market” index does. It should be based on your own personal or family index. Mine is based on the Doughty Family Index, and we measure where we are according to our plans, our goals and our tolerance for risk. But what we don’t do is derail our long-term plans because of short-term market ugliness. Nor should you. Check your emotions like you do your luggage then sit back, grab a drink from the beverage cart, and enjoy your flight.
As seen in Society Charlotte Magazine – March 2014, written by Edward R. Doughty, CFP®
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