What if the markets do this coming Monday what they did on Black Monday, a term ascribed to one of the Mondays in October of 1987 (October 19th to be precise) when stock markets around the world crashed for no apparent reason, shedding a life-altering value in a few short days? Dow that day dropped 23% which of course was followed by fear and panic gripping both Wall Street and Main Street alike. So what would you do if that were to repeat this Monday? What should you do? As always, pretty much nothing. But if you can, you re-jig and re-balance your asset allocation to bring it in line with your plan which then turns this temporary (hope no Japanese investor is reading this) disaster into a profit making event. And remember and accept the fact that in this journey to financial independence, market corrections and crashes will happen from time to time.
But, but why wait for the markets to crash and endure that gut-wrenching shrinkage in your net worth. Instead, why not get out of the markets before they crash and get in right before they start to rise? Great question. And it’s perfectly reasonable to assume that if it’s not you, your financial planner at the very least has an answer to that. You want him or her or his firm to have an informed viewpoint about what the markets, interest rates, currencies and commodity prices are likely to do next. You want advice on how best to capitalize on what’s happening in the markets before it happens. You want someone to help eliminate all uncertainties from your life.
So you go looking but unfortunately, the existence of that person with divine insights can only be found in Harry Potter. Sure you will find folks here and there who predicted market events correctly once (Elaine Garzarelli anyone) or sometimes twice but then you would have lost your shirt if you acted on any subsequent forecasts of these ‘experts’. And we understand how deep this yearning to know about what the markets are going to do next is. But in order to reach your goals, you’ve got to let that fantasy go. Rather than pretending to have answers we don’t have, the best strategy is to acknowledge this uncertainty and deal with it. Better yet, capitalize on it. We talked about that, right?
But before delving into the when and how, a few reasons why trying to anticipate market events is an exercise in futility.
Data a bit old but not much changes. So you miss the 10 best days in this 20-year investment timeframe and your annualized returns drop by 40%. Think about it, just 10 days in 20 years. Miss the 20 best days and you might just pack up and save, not invest, save in US treasuries instead.
The impact on your wealth…
Dalbar in their 2011 Quantitative Analysis of Investor Behavior report highlight a couple startling stats –
- 20-year annualized return for the S&P 500 ending in 2010 was 9.14%.
- What did a typical equity mutual fund investor earn? 3.83%.
What’s behind the big gap? You guessed it.
So clearly, attempting to move in and out of the market to catch the best possible time to be in the market can easily derail your investment plan. And we know that investing with this anticipation mindset is a loser’s game but how do we deal with the volatility that is oftentimes inherent in our portfolios? By adopting the strategic route.
Investment managers typically fall into two broad camps; those who approach markets and investing strategically vs. those who employ a more tactical approach to money management.
Tactical investors are constantly changing their portfolios. They are always trying to decide what the next best move might be. They look at the markets every day from the perspective of finding something better for their portfolios. And when they do, they sell their current investment in exchange for that better one. Tactical investors feel like they are “in the game”. They are making decisions all the time that they believe will get them closer to reaching their goals. And, let’s face it, it’s much more fun. It’s more fun to be “in the game”. It’s more fun to make things happen than it is to let things happen. And more importantly, it gives you something to talk about at that next cocktail event…but of course you only talk about your winners.
Cocktail party discussions aside, reams and reams of data conclude that tactical investors routinely underperform market averages. Just look at any managed mutual fund’s scorecard over any 5-year and 10-year window and you will find that not only do tactical investors underperform market averages but investors pay dearly for this underperformance in the form of excessive management fees, taxes and trading expenses.
Strategic investing on the other hand is a long-term approach based on prudent asset allocation, asset location, opportune re-balancing and efficient tax planning. Utilizing tried and true portfolio design techniques that relies on the Modern Portfolio Theory, Mean-Variance Optimization and data analytics, strategic investors akin to traditional pension fund managers, construct and maintain an investment plan to meet specific life goals while keeping taxes, trading costs and investment management expenses to a minimum. It’s the 100-yard dash for the tactical investor versus the strategic investor’s marathon, like that fable about the tortoise and the hare. And we all know who wins.
More importantly, a strategic investor acts based on what has already happened whereas a tactical investor acts in anticipation of what is going to happen. Think about it, in one case you act based on facts and in the other case, you act based on a hunch. Do you want to manage your life savings based on hunches?
If you believe in astrology or tarot card reading, you might be more inclined to be a tactical investor. For all others, take a strategic approach and sleep easy. Market crashes will come and go but you will still have to send your kids to college and plan to retire someday. A sound investment plan with an optimal asset mix and with a bit of fine tuning and re-balancing will almost guarantee that your family’s journey to financial independence will end a lot sooner than it has to.