Scary Markets

Let’s play a game. I offer your choice of (A) $1 million in cash now, or (B) a magical shiny penny that doubles in value daily for 31 days. Which do you take? Of course it’s a trick question. Take the magic penny! It’ll be painfully boring early in the process (1 penny turns to 2, 4, 8, and so on), but things later get exciting.  End of week 1 you have $1, week 2 its $100, and week 3 its $10,000. You hit $5.4 million on day 30. And double that, you have $10.7 million on the 31st day. Compound interest is a powerful yet basic principal in personal finance. Consistency and time matter. You save and invest X dollars monthly, reinvest the profits, and you’ll achieve your goal – buy a newer vehicle, fund college or trade school, or retire on your terms.

But it’s not easy for three reasons. Patience wears thin as people don’t want to wait and put in their time; and they’d rather jump ahead for the big payoffs. Imagine the boredom and pain – the first couple of weeks of the magic penny, starting up a new fitness regimen, or breaking an old habit. Second, life tends to get in the way – an unexpected expense, job change or health event. And third, a crisis du jour occurs that cripples the markets temporarily, brings fear, and investors behave irrationally. So let’s talk scary markets.

They’re natural and frequently occur. In every four year period, there’s usually one great year, one terrible, and two mediocre. You’re probably happy in those great years. However, the down years really elevate stress. That’s also natural. Its call risk aversion. We’re hardwired to survive – seize favorable conditions and avoid or neutralize threats.

And that’s when you ought to be talking with your trusted advisors – When fear is high and you seek confidence. I’ve found those conversations to go something like this:

“Have you seen what’s going on? The market is down/ABC is going to get elected/XYZ crisis du jour. I want you to sell everything.”

We feel your stress. Standing on the ledge is serious stuff. Is it a permanent decision?

“No, I’ll get back in when the dust settles/things get better.”

Please help me understand. What does “dust settles/better times” look and sound like to you?

“The news reports will be better.”

Ok. When the news is better, where do you think the market will be?

“Higher.”

I’ll be professionally candid. This sounds like selling low and buying high. What am I missing?

Life is abundant with irreducible uncertainty.  There’s always something that will knock us off track. And when we’re thinking about making the Big Mistake. Here’s one – chasing past performance.

One of the hottest performing investment sectors was long government bonds and credit – up about 6.5% for the quarter and 14.3% year to date through June 30. And it’s tempting to rebalance your 401k plan by picking the highest performers from the menu of investment choices. Lipper reported that investors took some $6.1 billion out of equity funds and put $4.1 billion into taxable bond funds for the first week of July.

In volatile times, investors tend to run to safety by selling “riskier” assets (e.g. stocks) and buying “safer” assets (e.g. bonds). That’s driven bond prices to record highs and yields (interest rates) to near record lows. But how likely is the future to resemble the past – specifically, which way do you think interest rates are eventually headed? When interest rates rise – investors will see lower bond prices.

And remember the Rule of 72 – it’s a quick formula to see how long it takes money to double. You divide the number of years (or the return) into 72 – it’ll take 10 years for money to double at 7.2% return, or money will be worth half in about 24 years assuming 3% inflation. Using today’s rates, it’ll take about 107 years to double your savings in 1-year US deposit account, 1,387 years in a German account, and 6,932 in a Japanese account.

Please don’t misunderstand me. Investing in fixed income is often prudent in a diversified retirement account. It generates cash flow (e.g. retirement paychecks) and is a good buffer for volatility. Rather, don’t drive by the rearview mirror alone (past performance) – look ahead and avoid the obstacles in the road, and talk with your trusted advisors. And as an Irish blessing goes, “May you live as long as you want, and never want as long as you live.”

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