Not long ago, a friend expressed concern about the stock market. He talked about problems in Washington, D.C. and terrorism abroad and then he asked, "Doesn’t it concern you that the stock market keeps going higher even though the world is going crazy?"
My friend isn’t alone in his worries. In a recent Gallup poll, 25 percent of Americans mentioned dissatisfaction with government or poor leadership as the top problem facing the United States. Economic issues came in second place with 19 percent, while terrorism (8%) and healthcare (7%) were a distant third and fourth.
As unsettling as these issues are, most significant world problems do not lead to bear markets. If you run for cover every time there is a reason to feel pessimistic about the world, you are going to be very frustrated as the market continues to advance anyway.
So how does a successful investor deal with an uncertain world? Above all, stay invested. Time in the market is much more important to investor success than timing the market.
This fact is highlighted by a study published by J.P. Morgan examining movements in the S&P 500 stock market index from 1980 through 2016. In 28 of the 37 years studied, the market ended the year with a gain. Yet in each of those positive years, the market also experienced a period of decline lasting from several weeks to several months.
These short-term declines were performance traps. If you tried to time the market by selling every time the market went negative, you would have lost a significant amount of your wealth over those 37 years. However, if you stayed invested, your wealth would have increased several times over.
Effectively dealing with uncertainty also requires that you keep your investment horizon in mind. Your investment horizon determines what kinds of news and market developments are important to your success.
For example, early in my career I worked as a bond trader for a large bank in Los Angeles. Later, I was a futures and options broker in London. My investment horizon was extremely short—sometimes measured in minutes. Both jobs required me to react quickly to breaking news. Short-term market swings had a significant impact on my success or failure.
My perspective changed when I was hired to manage institutional portfolios. In that role, my success or failure was measured over longer-term horizons. News developments were still important, but short-term market movements were more of a distraction. My job was to capture the power of long-term market trends.
Most people have investment objectives that are longer-term in nature. Whether they are investing for retirement or college or some other goal, their investment horizons are usually measured in years, not minutes. However, some people with long-term horizons still approach news and market developments with a trader’s mentality. They want to buy when the market is hot and sell before it turns cold. Unfortunately, their attempts to time the market generally work against their long-term success.
A better approach is to build a well-diversified portfolio of high quality investments and then to let the markets do their work. If your investment horizon is greater than five years, a larger portion of your portfolio should be in stocks. As your horizon shortens inside of five years, your portfolio should hold more bonds.
Steven C. MerrellMBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA93940 or email them to firstname.lastname@example.org.