Blog post #409
When we provide investment advice and write in these blog posts, we recommend to focus on the long term, especially with regard to investments in the stock market.
A client recently asked me how that “long-term” perspective applies to him, as he is “older” and feels that his time horizon is not as long as he once perceived it.
This is a valid question, so I thought it would make sense to address it.
Let’s start with a basic premise, that if you invest in the stock market, including a globally diversified portfolio as we recommend, you must be prepared for a significant loss of your money over a relatively short period, which could be anywhere from months to a year or two. Stock markets can and do drop quickly and significantly. In order to reap the benefits and gains of stocks, you must be willing to endure the down periods.
In real terms, you could see a decline (loss) of 10-20-30-40% or even more, of whatever money you invest in the stock market, at any point in time. This has happened before and it will happen again.
This is where your time perspective and the reality of the stock market come together. We encourage you to view stock market losses as temporary, and not permanent losses. If you don’t sell at the bottom or during down periods, you should be able to recover from the temporary losses in the stock market, depending on your situation and your timeframe.
As you can see from the following chart, each major loss of greater than 20% of the S&P 500 since 1926 was fully recouped within a few years. For each period, for down and up markets, the chart shows the number of months and the percentage loss and gain over the respective time period. For example, the tech meltdown that started in 2000 resulted in a downturn of 45% in the S&P 500 and occurred over 25 months. Over the next 61 months, the S&P 500 gained 108%.
Please note that this chart is presented for illustrative purposes, to help you understand that stock market losses are temporary and not permanent. We recommend portfolios that are much more diversified than just the S&P 500 (which includes US based large companies only and the companies in the Index have changed significantly over time) so the performance of a portfolio that we recommend may have done better or worse during these specific time periods, but the concept would still be valid. Losses are temporary, not permanent, if you can be disciplined and patient.
The client who posed this question asked me how we factor his “shorter” time perspective into his planning.
When we determine the allocation of a portfolio – how much is invested in stocks v. how much is invested in fixed income (bonds, CDs and cash, which are considered safer and not as volatile as stocks), we focus on your need, ability and willingness to take risk.
And this is where the time perspective begins to take part in the planning and advice that we provide. This is very personal and may be different for each person. For someone such as this person, he may feel he does not have the willingness to take on as much risk, due to his or her age. But we also have to factor in the need for growth in the portfolio, which can really only come from the stock allocation. We also consider his ability to handle the risk, which is likely a factor of age, as well as each persons’ emotional ability to handle volatility. Thus, we would hope that we can recommend a portfolio that has an allocation to stocks that will enable each client and their family to be able to meet their lifetime financial goals and desired cash flow, as well as be at a level of stocks that they can handle emotionally.
Since any money invested in the stock market is subject to loss, we account for someone’s shorter time perspective by adjusting (reducing) the percentage of the portfolio that is invested in stocks.
As we said above, a key part of our philosophy is that stock market losses are temporary, not permanent. But you have to remain invested in stocks, in order for them to recover….and you can’t know how long the recovery will take, especially in the midst of a market crash, such as occurred in 2008-09, or even last fall and through December, 2018.
For most people, this type of analysis and planning is in respect to their retirement portfolio. In this case, your life expectancy is what should drive your time perspective. Based on Social Security life expectancy data, for which 2016 is the most recent published, someone at the respective ages in 2016 should live, on average, to the following ages:**
|60 Year Old||82||85|
|70 Year Old||84||87|
|80 Year Old||88||
Also, keep in mind, that this means that half of the population is expected to live longer than the above figures and half will live less. These are the mid-points. Further, it is clear that for people who are better educated, wealthier, and presumably have better access to good health care, they would be expected to live longer than the average. However, as we all know, the only statistic that counts are yours, and the ones you love, not the averages.
But for planning purposes, unless you have a specific medical condition that you have shared with us, we would rely on this type of data. Thus, for someone who is around 60, we would view them as having at least a 20-30 year time perspective. For someone who is 70, we would want to plan for a 15-25 year time perspective.
This is really important. You may be in your mid-60s and not feel that you can think long-term as it relates to stocks. But we encourage you to think long term, as we view it. We have many clients who are well into their 80s and 90s. I’m sure that each of you know people like that. We need to plan so that your money can last for a very long time while you live in retirement.
There are other situations, such as college savings plans or certain employer incentive programs, which have specific timeframes or ending periods, where the money will or should be distributed. In these cases, we would plan very differently than for someone’s retirement funds, as these situations may really have only a 5 or 15 year ending point. In these cases, we would recommend that the closer one gets to the end of the time period, or closer to the college years, the money in this type of account should get much more conservative, reducing the stock allocation to 10-20% or even less, in the final year or two.
As your advisor and guide, we can help you deal with these varying, emotional and financial issues.
- All aspects of investing and financial planning should include discussing your emotional ability to handle risk.
- It should include evaluating what is the appropriate time frame for your investments. You may have differing bucket of assets with varying time perspectives.
- We encourage you to think long term, especially in light of longer life expectancies. You may live into your 80s or 90s and we need to plan for that.
- Based on this, if you have a 20-30 year life expectancy, you should have a long term time perspective to be able to recover from temporary stock market losses.
We hope this information is valuable and helpful to you.
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We hope you have a safe and good holiday weekend.
**”Life Expectancy Table,” https://www.ssa.gov/oact/STATS/table4c6.html, webpage as of 08/29/2019