Happy New Year! 2022 was a bad year for both the stock market as well as the bond market. The S&P 500® will finish the year down almost 20% and 2022 might end up as the worst year for the return of the bond market after the Fed raised interest rates while trying to contain inflation. Here’s a question for you. What are you going to do if this continues into 2023?
Things to Consider
I’m going to focus this piece on people who are contributing on a regular basis to their 401(k) plan or some other regular investment program. This will apply mostly to people in the accumulation phase of their investment lives.
I read an article from a guy named, Nick Maggiulli. In it, he stated that big down years, historically tended to be followed by big up years. But that doesn’t always happen. What are you going to do if the losses continue in 2023? Are you going to bail out? Are you going to move your long-term investments into a savings account that is paying 3-4%? After all, 3% is better than more losses, right? You can always get back into the market when the returns get better.
Personally, I’m not a big fan of this plan. The stock market is supposed to do this. The reason you get a better return from the stock market is you are getting rewarded for the volatility. It’s called the risk premium. You get paid an excess amount of return for taking on additional risk or volatility. Assets without risk pay less return. That’s the reason the returns on a savings account are much lower over time than the returns on the stock market. You’re not going to lose your principal on your savings account, but you could lose principal on your stock market investments.
The other observation about trying to do this plan is you have to make two correct decisions. When to get out and when to get back in. The first decision is relatively easy. The second one is hard. The old adage is buy low, sell high. The problem is they don’t ring a bell when the market hits the bottom. It’s just another day of bad news. But suddenly, for some unknown reason things change. But people wait until the market goes back up and then, maybe, they decide to reinvest. By then they might have missed out on a lot of the positive returns. In essence, you’re buying high again.
Look at the Number of Shares You Own
When I do 401(k) review meetings, especially during years like these, the investment reports show a negative rate of return for the year. I start hearing things like, 401(k)s suck and my 401(k) is now a 201(k). One thing I ask people to do is look at the number of shares you owned last year versus the number of shares you own now. Even though the price per share has dropped, almost always, you own more shares of your mutual fund or ETF, etc. now than you owned in the past. Not only are your contributions as well as your employer’s contributions buying more shares, but you also usually have dividends and capital gains from the funds that get reinvested and buy more shares. When the prices eventually go back up, you have more shares that are worth more money.
What is the Money For?
Whenever someone comes to me and says they want to invest their money, I always ask them, what’s the money for? Inevitably they look at me like I’m an idiot and say something along the lines of, I want the money to grow? For what? Is the money for buying a house next year? Is it for retirement? Is it for your kid’s education? If so, when do you need the money? How long does this money need to last? Etc., etc.
When you’re in the accumulation phase like we are talking about, usually your investments are for long term needs like retirement. For a lot of people, their retirement date is a long way off. Even if you’re closer to retirement age like me, you’re still going to live 30 years or more after you retire. In situations like these, we need to have investments that will grow over the long term. Most people want their money to grow because they know things are going to cost more down the line than they do today. For example, we bought a rental house in 2006 for $120,000. Today that house would sell for $260,000. The rent we charged in 2006 was $750.00 per month and now we charge $1350.00.
I bought my first car in May of 1986. A brand-new Honda Civic DX hatchback. If I remember correctly, it cost $7500, my Dad put $400 down and I financed it at 8% on a 4 year note with a monthly payment of $173.00 per month. Today, a similar car costs between $25,000–$29,000.
If you know you want your money to grow because you also know that things are going to cost more money in the future, then you can’t just save your money under the mattress or keep it in your savings account. You’re going to want to invest the money in instruments that will grow. The problem with this is, for your money to grow, you are going to have to take some risk.
Trading Risks
When we talk about risk in the investing world, I don’t think we are really talking about risk. We are really talking about volatility. The definition of risk is, a situation involving exposure to danger. Take the stock market for instance. I don’t think there is really danger. You’re not going to get killed. You can’t fall off your bike and shatter your femur in the stock market. Instead, you are exposed to volatility. How do you emotionally handle something going up and down? For some people, the volatility doesn’t bother them. For some people, they say the volatility doesn’t bother them until their account value drops. Then they suddenly get bothered.
With most investments, the higher the potential rate of return, the greater the volatility. I have been telling my clients who were invested in the stock market last year and experienced a -20% rate of return for the year, it’s supposed to do this. Your investments are supposed to go up and down. I have looked at various charts that have shown 20-year returns for stocks around 7%, the returns for bonds around 4% and the returns on cash around .5%.
Now back to trading risks. It might feel good when the stock market is really volatile like it has been lately to move your money to cash. You know your investment won’t go down, so you think there is no risk. In reality, you are trading the risk of volatility for the risk of loss in purchasing power in the future. That goes back to my question, what’s the money for? For short term needs like a down payment for a house or you have a senior in high school who will be starting college next year, return of your money is more important than the return on your money because you don’t have enough time to recover if the value drops.
For those of us with long term needs like retirement and keeping up with increasing costs for the rest of our lives, the volatility is worth the increased returns.
In conclusion…. (sort of)
You’re in the accumulation phase of your investment life. 2022 sucked. Stocks were down, bonds were down. Inflation is high. The Fed keeps raising interest rates. Housing is starting to drop. There’s talk of an impending recession. What if 2023 is more of the same? So what? Put your head down and just keep buying shares. Investments that have higher returns generally have higher volatility. It’s just the way it goes. If you want to talk more about this, reach out to me HERE. As always, thanks for reading and Happy New Year! KB