In a span of less than six months, investors have seen the broad equity market (S&P 500) go from an all-time high to a decline of over 20%. For other indexes like the NASDAQ, which is heavily weighted in technology companies, declines have been even greater. More surprisingly to some investors, bonds have fallen in value as interest rates increased in response to higher-than-expected inflation. What is a long-term investor to do? Now may be a good time to revisit what we believe to be a few irrefutable truths of successful investing.
Stocks are volatile in the short-term and these inflection points, up or down, cannot be predicted with any degree of consistency. Declines in the stock market always prove to be temporary as the growth of the world’s population and economies propels the valuation of publicly traded companies upward. Although investors have many different goals, we all share at least one goal, that being to earn a rate of return greater than inflation, net of taxes. If you are not exceeding inflation your purchasing power is falling. To beat inflation, you must own assets that grow in value at a rate greater than inflation. Equities have done that, averaging about 6% per year above inflation over time.
The late Sir John Templeton, one of the world’s most respected investors, said the four most dangerous words in the English language are, “This time is different.” Another equity legend, Peter Lynch said “The key to making money in stocks is to not get scared out of them.” Investors put at risk attaining their long-term goals when they attempt to time the market and history has proven time and again that the best strategy during times like these is to sit tight or act strategically, but not react.
What about bonds? For all but the most risk-tolerant investors, bonds offer a way to temper the volatility of an all-equity portfolio. That reduction in risk comes at a cost, lower expected returns. In essence, bonds allow many investors to stay fully invested in their stocks. Followers of our firm know that we have been advocates of short-term, high-quality bonds which are less sensitive to interest rate movements than longer-term bonds. Even so, short-term bonds will fall in value (temporarily) as interest rates rise, since bond prices move inversely to interest rates. However, as they mature, the proceeds will be reinvested in new bonds at potentially higher yields. Thus, a temporary pain produces a greater gain. As bad as higher interest rates are for borrowers, we welcome the opportunity to earn a greater yield from our safer assets.
Investors who go it alone have no one in their camp to whom they can turn during such uncertain times. This is where dedicated, experienced financial advisors earn their keep. They act as a sounding board when called upon to help calm their clients’ nerves, reassess their financial plan and its corresponding investment strategy and attempt to help them think clearly and act rationally. They allow their clients to turn their focus away from things they cannot control and back to things they can like time spent with family, friends, careers, hobbies and causes about which they care most.
This too shall pass.