By Joe Delaney
As a former lifeguard, I often use the analogy of swimming in the ocean to describe what it’s like to make and sustain investment plans. It can help you as an investor to think of financial markets as vast and full of potential, but also risky should you decide to venture out.
The analogy has its limits at times like these, however. Lifeguards on a literal beach put up a red flag when the water gets choppy. It indicates the risk is too great to enter or remain in the water for most swimmers until we put up the green flag. It means your plans should change.
Here’s the problem with looking at markets that way. Historically speaking, there is never a green flag in investing. Moreover, that’s a good thing, and often has little to do with your investment plans.
Let me explain.
THE OCEAN WILL ALWAYS MAKE WAVES: RISK
There’s a reason you come to the beach instead of staying in your own pool. The waves – the very aspect of the ocean that can put swimmers and surfers at risk – are the draw. Sometimes they provide an exciting lift. Other times, you feel them come crashing down over your head.
It helps to get perspective. The Dow Jones Industrial Average has experienced 15 bear markets over the last 100 years, which is defined as a drop of at least 20%. During the Great Recession, from October 2007 to March 2009, the drop was 53.8%.
How does this compare to the fourth quarter of 2018? The DJIA dropped 16.3% from October through December 24th. The drop does not qualify as a bear market.
It might provide little comfort to you to think of this wave crashing down as comparatively smaller than down periods in the past. Thankfully, in this ocean there are other, more important factors to consider besides how the water feels to determine whether its risks outweigh its rewards.
READ MORE HISTORY, LESS NEWS: PERSPECTIVE
If you look hard enough for them, you’ll always be able to find stories of injury or even the drowning of overconfident swimmers in the news. It’s tempting to make decisions about how to behave in the water relative to decisions others are making.
In investing, economic indicators based on history provide a much better yardstick than the short-term performance of other investors. BAM Alliance research director Larry Swedroe points to a strong economic growth forecast for 2019 (GDP growth of 2.7%) compared with historical data; the lowest unemployment rate in 50 years (3.7%); and other indicators that causes him to conclude:
“The bottom line is nothing in the economic data indicates we are headed into a recession that could lead to a bear market (with the stock market being a leading indicator).”
Adopting a historical perspective helps us avoid a panicked response. Selling off means engaging in the tricky game of market timing (and possibly the realization of gains). When do you go back into the water? History doesn’t tell us that, not precisely. It only tells us that the slide downward – the reason you sold off – was normal.
It also tells us that, again, there will never be a green flag telling you precisely when to get back in. You likely will not have mitigated risk; only delayed it a while.
TRUST YOUR SWIMMING ABILITY: RISK TOLERANCE
Were you a strong swimmer when you first got in the water? If so, there is a certain amount of volatility on the surface of the ocean you can safely tolerate. You may need to move around into different waters, or a bit closer to shore; the point is, you know what you’re doing. There is no need to fear.
In investing, your “swimming ability” is the soundness of your long-term strategy. Is it low-cost? Is it based on academic research and facts? Is it built around a disciplined approach? These are your muscles, the strength of mind on which you can depend.
If you can’t trust the plan, you’ll never be confident in the water. You’ll do something unwise, flail about and put yourself at more risk than the danger you perceive. Most often, the best course of action is to do nothing. (Meaning: don’t panic, stick to your plan.) If you were strong when you entered the water, you’re strong now. Believe that and resist the urge to react out of emotion. It’s the best chance you have at reaching your goals.
LEAVE THE WATER WHEN YOU’VE MET YOUR GOALS: DISCIPLINE
Every swimmer must return to shore eventually. The primary difference between the investor and the swimmer is the duration of time you’ll spend in the water. A good plan is a long-term one. One year is usually not a “long time.” Historically speaking, even 10 years is often still not a “long time.”
Time is relative. We should never measure it based on how long it feels. We should always measure it against the benchmarks we have predicted.
Did that drop feel like a long time? That should be irrelevant. What matters is, was it a long time compared with the drop we anticipated in the plan?
We have been very busy here at Lifeguard Wealth the last few months rebalancing and harvesting losses for our clients. We like to think of it as making lemonade from the lemons the market has been providing.
That’s right, we have a plan for managing losses when they present themselves. Any good plan will be realistic, in that gains and losses are both anticipated over time. We work to maximize the gains and minimize the loss, but we expect that both will come over a long-term investment plan.
As your financial lifeguard, my job is to not only watch the shoreline and be ready to act when conditions change. More importantly, I prepare you to enter the market not at the perfect time, but with sound, evidence-based investment plans. This means, for most of my clients, my general advice for 2019 is going to be the same as it was for 2018 … follow your plan.Let’s stick to the plan, because the ocean is still a wonderful place to swim.
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The opinions expressed by featured authors are their own and may not accurately reflect those of the Lifeguard Wealth. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.