Well, it has been a heck of a ride these past few weeks with the weather we’ve had! Four nor’easters in three weeks! Our offices had to close for a time because of the weather, since, like many of you, we had no power. Even though we had to “rough it” a bit, everyone was home, safe and sound and we all emerged unscathed. We’re very grateful to all the hardworking utility line workers who were out there even before the storm was over to get us back up and running, and everyone else who kept us safe during the storm.
Severe weather events like what we’ve just experienced are par for the course for Cape Codders and New Englanders. Making sure we’re prepared for these events is old hat by now, especially as they seem to be happening more frequently these days. Stocking candles, non-perishable food items, gas for the generator, drinking water, and so on is almost routine. But it’s important to also have an emergency plan in place that everyone in the family knows: where to go, whom to call, and what to do if things go awry.
Having a plan in place during a weather emergency or other natural disaster is essential. So, while I was at home, in the dark, with three teenage ladies…I got thinking.
You know, it is just as important to have a plan in place for what to do in the event of a market nor’easter. But sadly, nearly half of Americans do not have such a plan, according to a new survey published by Country Financial. According to the report, only 28% of those surveyed said they have a financial safety plan in place; another 44% said they have no plan at all.
Although we’ve certainly seen some potentially worrying market fluctuations since the beginning of the year, we’re not in bear market territory – not even close as of the date of this column. A “bear market” is defined generally as a market-wide decline in stock prices of 20% or more over a two-month period.
At current trading prices, for us to be in bear market territory, we’d have to see the Dow Jones Industrial Average drop by over 4,500 points. We’ve seen short-term 1,000-point fluctuations, but nothing even close to that yet. But as I’ve explained to many of my clients over the years, a bear market does not start once stocks are down 20%. Many only see the downward trend in hindsight, unfortunately.
Folks, forewarned, as they say, is forearmed. Just like with a weather emergency or other natural disaster, you should have a plan to survive the bad weather on Wall Street, and the perseverance to stick to that plan when the time comes.
And this needs to be done…before the storm.
So, when you see market winds are blowing: You must remain focused on your plan. Separating your emotions from your investment decisions is one of the most important things an educated investor can do. Letting emotion guide your investment strategy is a great way to lose power.
Most individual investors are, generally, more averse to loss than they are to risk. The problem is that many investors aren’t aware of their investments’ potential volatility. When they design their portfolio, they focus on the upside potential of an investment rather than understanding its potential downside. And unfortunately, once the downside is revealed, many investors react emotionally.
This is evident in the findings of an annual study of investor behavior conducted by DALBAR, a leading financial services market research firm. For almost the past quarter century this firm has tracked the effects of investor decisions. In the most recent report, published last year, DALBAR found that the average equity investor underperformed the S&P 500 by a margin of 4.70%. The average equity investor earned 7.26%, rather than the 11.86% made by the broader market. The average investor only guessed correctly about the direction of the market the following month 42% of the time.
That’s because many individual investors too often think with their hearts rather than letting rules-based investment strategies guide them. We find that many times retail investors who, more often than not, subscribe to a buy and hold investment strategy will allow their emotions to get the best of them. This can lead to selling at the worst possible time when they stand to lose the most money.
Incorporating a tactical investment strategy that uses risk triggers can be a way to help minimize the risk of letting emotions guide investment decisions. Risk triggers can use certain historical indicators to focus on overall market momentum. Knowing that such a strategy is in place can allow individual investors to rely on those rules, rather than their emotions.
Understanding risk tolerance is also important. Have a clear understanding of your ability and your willingness to handle swings in the value of your investments. How much volatility are you willing to tolerate in a market downturn? How far away are you from retirement, and how much volatility can you afford to sustain?
If you discover your portfolio exposes you to more risk than you’re comfortable with, to adopt a more conservative risk tolerance profile – targeting strategies that may focus more on the preservation of capital.
Diversification is another essential strategy to help reduce risk and ride out market fluctuations. If your investment portfolio heavily favors a single stock, a single asset class like equities, or a single sector of the market like technology, you will feel the effect of any downward movement in that particular stock, asset class or market sector much more dramatically. Spreading your investment portfolio among different positions and asset classes can lead to less volatility, which will help you ride out those market fluctuations.
A strategy focused on managing volatility and reducing downside risk is key to the success of your investment strategy. Don’t let your heart rule your investment decisions. Instead, set rules, let your head guide you – with a strategy that helps you maintain your focus on your long-term goals, rather than short-term gains or losses.
By having such a strategy in place before the next storm, you know that you are prepared for any financial nor’easter you face.
Be vigilant and stay alert, because you deserve more!
Have a great week!
Jeff Cutter, CPA/PFS is President at Cutter Financial Group, LLC. A wealth management firm with offices is Falmouth, Duxbury, and Mansfield. Jeff can be reached at email@example.com.
Cutter Financial Group LLC (“Cutter Financial”) is a SEC Registered Investment Advisor.
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