The year 2019 was a great year for the US and international stock markets. Large-cap US stocks were up more than 30% measured by the S&P 500, small and mid-cap US stocks were up more than 25%, and international developed stocks were up nearly 23%. Meanwhile, earnings growth was down compared to 2018. A strong 2019 followed by what hasn’t been a great 2020 so far, and many investors are wondering: Is now the time to get out of the stock market and flee to safety? Are bonds and cash the place to be?
Predicting The Future Of Financial Markets
Making changes to your portfolio based on recent market events, or on your prediction of what’s going to happen in the future is the nature of market timing. If we knew for sure that the stock market was going to tank in 2020 and that the bond market would remain steady in 2020, then yes, of course it would make sense to sell stocks and buy bonds. Conversely, if we knew the stock market would post another stellar year in 2020 and that bonds would lag, then no, we wouldn’t sell our stocks. We’d put everything we could into the stock market!
A Losing Game
Sadly, it’s not that simple. We don’t know what’s going to happen in 2020, and trying to predict the future is futile.
I can hear it now. “But all signs are pointing to a recession!” “Experts believe a bear market is coming!” “My newsletter has an article written by this guy who predicted the housing crisis, and he says the next recession is in 2020!”
Lots of experts try to predict the future. Sometimes they’re right, and sometimes they’re wrong. You remember the ones that are right, and you forget the ones that are wrong. Research shows that timing the market doesn’t typically work. Part of the reason for that is because you have to be right twice. If you decide to get out of the stock market now, and you’re right, then when do you get back in to the stock market? If you never do, and the stock market grows, you lose money. Deciding when to get back in the market is another decision that could be costly if you do it at the wrong time.
A Better Alternative
Since you can’t predict the future, base your investment decisions off of three primary factors: your goals (how aggressive do I need to be to have a certain amount of money at a certain time?), your time horizon (when do I need this money?) and the amount of risk you can tolerate (how much can I lose without making a costly emotional decision?). The answers to those questions are a better way to figure out the appropriate mix of stocks, bonds, alternatives, and cash. Once you decide an appropriate investment mix, stick with your decision as long as those three factors remain the same.
Create a Rebalancing Process
Over time, your investment mix will change. For example, let’s say your portfolio is 60% stocks and 40% bonds. After the strong year the stock market had in 2019, your stock portfolio might have grown and become 65% of your portfolio, and your bonds might only make up 35% of your portfolio without you making any changes. Your stocks just grew faster than your bonds. Rebalancing your portfolio means you’d sell some stocks to get back to 60%, and buy some bonds to get back to 40%.
Rebalancing is essentially a way to “sell high” and “buy low” without letting your emotions get in the way. If you let your emotions drive your investment decisions, you’ll probably lose. Research in the area of behavioral finance shows that as humans, we’re naturally wired to be bad investors. So, creating a process to remove the emotion can help set you up for a better experience.
We recommend rebalancing your portfolio once or twice a year, and do it at the same time each year. Don’t try to guess when you should do it. Just set a reminder to do it every 6 or 12 months. Some 401(k) providers actually allow you to set up an automatic rebalance feature on your account so that you don’t have to remember to do it.
At Flagstone, we use rebalancing to help us remove our own emotions. We’re human after all, and we have emotions, too. But we know that when it comes to investing, we should use a process instead of trying to predict the future or letting our emotions get the best of us. Not only do we rebalance stocks and bonds, but we also rebalance sub-asset classes like US stocks and international stocks, or inflation-protected bonds and short-term bonds, for example.
At the end of the day, just remember to focus on what you can control instead of trying to focus on what you can’t control. Control your spending, save more when you can, and enjoy life! If you have trouble enjoying the more important things in life, maybe it’s time to hire a fee-only investment manager like Flagstone to remove the complexity and worry. There’s something to be said for the peace of mind that comes from having a professional help you through these types of decisions.