How Long-Term Investment Strategies can Mitigate your Ticker Risk
What is ticker risk? Don’t bother searching the internet as this is simply a term we occasionally use to describe the inherent risks that come with giving too much credence to the current price and daily changes of the S&P 500, Dow 30, and Nasdaq Composite Index. These three, main “tickers” represent the vast majority of what is displayed on most financial news sites, but they hardly provide an accurate view of what should be in a well-diversified portfolio.
As you know, at Financial Plan we believe in a disciplined, long-term investment strategy. Short-term stock market fluctuations, or “noise” as you may hear us say, are irrelevant to long-term success. However, the fact of the matter is that we are all constantly exposed to these tickers and it’s all too easy to be swept up in emotional responses that can disrupt your financial plan. Here are some rules and guidelines to keep in mind about these indexes to help mitigate your own “ticker risk.”
Compare Apples to Apples in Regard to Stock Market Volatility
If you are invested with Financial Plan, we have already constructed a massively diversified portfolio that will typically consist of over 10,000 stock and bond holdings from around the world. Meanwhile, the S&P, Dow, and Nasdaq indexes are all stock-only, primarily US-based, and focused on large companies. What does this mean? Since these indexes are stock-only, they are likely to be more volatile than your diversified portfolio, so there is no need to panic when you hear about large losses in any one of these indexes. We understand that markets are inherently volatile and combat this by planning in advance relative to your unique situation. We add bonds to your portfolio to provide a more stable asset class during these times.
The U.S. and large company focus of these three main indexes is also different than what is included in your portfolio, so comparing the two does not make sense. In 2017, emerging markets and international developed stock markets outperformed U.S. stock markets, making a globally diversified portfolio look better by comparison. Year-to-date (11/12/18) in 2018, the U.S. total stock market is positive while developed international and emerging markets are both down by double digits. If you break down returns of the U.S. stock market, it reveals only large cap stocks have positive returns year-to-date while mid-size and small companies have a negative return. Therefore, in 2018, a globally diversified portfolio will look significantly worse than a U.S., large-cap index. Since we cannot time nor predict which markets will outperform in short timeframes, we believe the best approach is to stay diversified and disciplined.
If you have a globally diversified portfolio, I would recommend comparing to a more appropriate benchmark such as the total world stock market blended with the total bond market (keeping in mind your ratio of stocks to bonds.)
For Diversified Portfolios, Think in Percentages, Not Points
When you hear the Dow dropped 600 points today, do you feel panic? Although this is a significant fluctuation, it is only about a 2.3% drop which is actually fairly common (2%+ daily swings happen about 20x per year). When we see these larger swings, thinking in percentages can help reduce emotional responses that can lead to managerial missteps. If you see that your account dropped $50k in one day, you may feel worried. But if you then realize your account is worth $5 million – making this a 1% change – you can put your mind at ease and remember that the ebb and flow is expected. By eliminating the emotional reaction, you will be more likely to stick to your long-term investment strategy.
We firmly believe in utilizing a globally diversified portfolio with the right amount of equity (stock) exposure for your financial situation. The apparent downside to a diversified portfolio is that you are never the “winner” in the short run. There will always be asset classes that are outperforming your portfolio. A major risk to your disciplined and long-term financial plan is comparing your portfolio to concentrated asset classes and letting fear or greed derail you.
Remembering that the stock tickers you are bombarded with daily are only indicative of a U.S. stock portfolio concentrated in large company stocks will help you follow through with your plan. We are here for the long run and it’s a marathon, not a sprint.
NOTE:
If you’d like to dig deeper int the numbers behind sticking to a long-term, diversified portfolio, the following article was released shortly after Devin wrote this piece. It does a nice job of diving into this concept we consider it a worthy read:
