Comments on recent stock market performance
FROM OUR JANUARY 16, 2016 E-NEWSLETTER:
... It hasn't been a Happy New Year in the markets since the beginning of the year. Global stock markets have had one of the worst starts to a calendar year in history. There's also been a lot of negativity in the media (as there tends to be anyway) with reporting on the campaigns of our upcoming Presidential election, incidents of domestic and international terrorism, concerns about the direction and health of our country, challenges with immigration and racial issues, questions about a shrinking middle class, and so on.
We wanted to touch base and remind you that the items you hear about in the media and the performance of the markets are things that are generally beyond your (and our) control. Instead, we think it's important to focus on the things that are within your control for having a successful financial plan and positive investment experience to achieve your goals.
1. It's a fundamental rule of investing (and life) that risk and return are related. As always, it comes down to how much risk you're willing to take in your investment portfolio in order to achieve long-term reward. That's why it's so important to have the right Investment Policy Statement (IPS) for your portfolio to determine how much risk you should be taking with your investments. If you have any concerns about your portfolio's IPS and you'd like to discuss this further, please let us know at any time.
2. If you need funds for your cash flow planning in the next 2 years, we generally recommend having these funds be in cash (or CDs or other liquid short-term instruments) and not be invested in the markets. You may have upcoming college tuitions to pay, you may be retired and are drawing down from your portfolio, you may be needing a down payment for a house or other significant purchase, or you may have any number of other cash flow needs in the short-term. Academic research in the financial planning industry and our direct experience of working with clients suggests that having this 2-year cash cushion is a sound strategy. This way, the markets' performance has no impact your short-term cash flow needs and you can have peace of mind for your immediate needs.
3. You may also be concerned that interest rates are likely to be rising (although it's impossible to predict with accuracy what interest rates will do at a given time), and this could negatively impact the fixed income component of your portfolio. Particularly during a time when the stock market is also down. If you have this concern, we're happy to speak with you in more detail about it. For now, we want to mention the following points:
a. The bond market may respond to current events differently from the stock market. The bond market also doesn't operate in a vacuum. If the stock market is down, investors are likely seeking to move their money into bonds, which should help the performance of bonds.
b. Fixed income managers, such as Gannett, Welsh & Kotler (GWK), are looking forward to interest rates rising! A significant part of the return you get from owning bonds comes from the interest a bond pays out. As bonds make their regular payments, fixed income managers can then reinvest those proceeds into newer bonds paying the higher interest rates. This compounding of interest can have a powerful long-term effect on the performance of owning bonds.
c. As long as a bond doesn't default, bonds have a guaranteed return. Bonds will pay a specific rate of interest at the specified payment schedule, and then mature at par on a given date. While the value of the bond may fluctuate during its lifetime, a bond manager has the option to simply hold the bond until its maturity and get its guaranteed rate of return. This is one of the reasons why we suggest owning high-quality bonds for your fixed income portfolio.
4. We're confident that we're using the best-in-class investment management service providers in Dimensional Funds (DFA) and GWK. While we can't control what the markets do, we can control the investment philosophy we use for managing your portfolios. DFA and GWK share this same philosophy that we've communicated to you. While past performance is no guarantee of future results, we think history is instructive because history is about human behavior and that hasn't changed in thousands of years. And the history of markets and investors' behavior is that investors have been rewarded in the long-term for taking the appropriate amount of risk for their given financial situations.
If you have any questions about your portfolio, the markets, your overall Financial Model, or anything else, please let us know.
Thank you again for having us be your advisor!
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