We’ve all heard the phrase, “Nothing is certain but death and taxes”.
While this may still ring true, technology, discipline, and planning are extending lives as medical advances, lifestyle changes, and healthy habits (when was the last time you were asked about sitting in the smoking section?) are all impacting the quality and quantity of life.
Fortunately, planning and discipline – and yes, even technology – can also reduce taxes, particularly for those who thoughtfully plan and invest while considering tax implications and strategy.
A tough start to the year
For the Dow, which was down by 15.3%, this was the worst start to the year since 1962. For the S&P 500, which was off by 20.6%, the first six months was the most challenging period since 1970.
The NASDAQ and Russell 2000 fared even worse and set all-time records, off by 29.5% and 23.9%, respectively. Even bonds struggled, with the Bloomberg US Aggregate Bond Index off nearly 10% during the first half of 2022.
Of course, there has been plenty for investors to worry about with rising interest rates, inflation hitting levels not seen since the 1980s and the talk of recession ever more prevalent.
So, what does this mean for investors? Fortunately, as with health and taxes, planning and discipline still matter and there are many reasons for optimism.
Of course, this doesn’t mean that the markets won’t face challenges in the second half of the year, or that the Fed will be able to navigate the delicate balance of achieving a so called “soft-landing” and avoid recession.
However, recessions are natural events and tend to be relatively short, with an average duration of just 11 months.
Of course, it remains to be seen if we will have a recession, though some signs might suggest this is likely or may have already started, as bear markets can occur without a recession and vice versa.
Discipline matters
The difference between investment returns and investor returns has been significant over time, and recent data reinforce the implications for investors.
In 2021, the gap widened significantly, with the average equity investor earning 18.39% vs. 28.71% for the S&P 500.
While the gap in 2021 was much higher than the long-term variance, over the past 30 years, the average equity investor earned 7.13% vs. 10.65% for the S&P index.
The moral of this story is not indexing, but rather the importance of staying invested. The Dalbar study, which now covers nearly 40 years of data, demonstrates that investor returns consistently underperform average mutual fund returns.
The issue is timing and when most investors buy and sell. Most follow the crowd and buy funds after they have had a few years of positive performance.
Unfortunately, this results in many buying after the gains have been realized. Many will follow the same pattern and sell after returns soften only to repeat the same process with a new fund.
The key is to follow a disciplined plan and process. Investing in a diversified portfolio of solid funds, ETFs and other investments, and having a well-defined process regarding adjustments, including when and how you will rebalance the portfolio to account for changes in markets and valuations.
Today’s environment is a great example, as the market has changed dramatically over the past few months.
Markets tend to anticipate recessions
Historically, most of the market declines associated with recessions occurred prior to the actual recession.
In fact, if you analyze market data over the past 70 years, stocks performed worse in the year prior to the recession than during the actual recession.
It is also important to note that most recessions are not like the recent variety, which is the only experience many investors (and even advisors) have with a recession.
The Great Financial Crisis of 2008-2009 had a stronger and more prolonged impact on markets and the economy than most, while the 2020 recession was the result of the pandemic and was the shortest on record.
The typical downturn in the economy is more gradual, with an average duration of 10.3 months.
In addition, the beginning and end of recessions are determined after the fact, when revisions to economic data allow economists to accurately calculate when we entered and exited the recession.
As a result, it is important for investors to consider both current economic conditions as well as market valuations when finetuning their portfolios.
It is also worth noting that economic forecasting is challenging at best, with leading economists often taking different (and even opposing) views on the outlook and implications for financial markets, further reinforcing the importance of a disciplined strategy and approach.
Opportunity in the midst of fear
Since 1950, the average bear market decline has been 29.8%. If we can avoid a recession, the decline is likely to be more modest.
If we have a recession, it will be a bit more severe. There have been eight bear markets without a recession since 1950, with an average decline of 23.8%.
While challenging and certainly not fun, bear markets are a natural part of investment and financial cycles. They also represent a wonderful investment opportunity.
As legendary investor Warren Buffet noted, “Be fearful when others are greedy and greedy when others are fearful” – great advice that can guide investors during both trying times and times of euphoria.
Both are fleeting, and considering value both high and low will allow investors to mitigate risk and weather the inevitable storms that are all part of investing.
Nobel Laureates Fama/French analyzed market returns after 20% declines from 1926-2021.
While there are certainly exceptions, the market was up an average of 22.2% over the next year and 41.1% over the next three years following a 20% decline.
Weathering market declines requires both patience and discipline. Discipline during boom times provides protection during the ensuing decline.
Patience, staying the course, and following a sound investment approach will allow investors to sleep well at night with the confidence that their portfolio will achieve reasonable long-term returns and can weather the inevitable market gyrations that confound many and reward those with the patience and discipline to stay the course.
Bill Van Law is the founder and CEO of WVL Group.