How much attention should we pay to financial news?I don’t care what’s in the headlines. Much of what’s in the headlines today will not have a material impact on an investor’s portfolio in the next decade.
I say that because many of the big-picture trends that had an impact on the stock and bond markets in the 1980s and 1990s weren’t readily apparent on any one day back then.
Some of the salient trends were the rise of globalization, falling inflation around the world, the rise of China, the fall of communism.
There wasn’t any one day when you could say, “My goodness, China is going to become the second- or even first-largest economy in the world” and invest accordingly.
If you pay attention, though, what should you do, if anything?An investor may ask, “Should I change my portfolio because the Federal Reserve is going to raise interest rates or because the dollar will rise in value?”
Well, first of all, yes, those are likely, but the financial markets already know that.
The financial markets already have given high probability that over the next two years the Federal Reserve will raise rates one more time, probably two, so that is already reflected in current stock prices.
Similarly, it’s amazing to me that someone will say that China is slowing down and ask if they should adjust their portfolio accordingly. But China has been slowing down for the last five years and it is likely to slow down significantly more over the next ten years.
But the financial markets have already come to that reality and in determining stock prices have already priced in that lower growth for all emerging markets over the next few years. So it’s not good enough to see that emerging markets are slowing down and ask yourself, “So should I make a change in my portfolio?”
What would be more important to ask yourself as an investor is whether emerging market growth or Chinese growth is better or worse than consensus. Only then would it be possible to contemplate making an investment change.
But even many fund managers have difficulty trying to answer those questions.
Though they and other experts try to predict economic and financial trends, right?There are some studies that show that even well-known economists and fund managers who forecast what the economy or markets will do generally don’t do so successfully.
There is always someone who will call the next crisis, but that is not the same person who called the last one. Or if they did, they also called for ten other crises that didn’t materialize.
Finally, one thing to also keep in mind is that, despite the fixation today on what the Federal Reserve will do about interest rates or what will happen to the economy in China, there are likely to be unexpected things that will affect the markets, that over the next five years are likely to have a bigger, broader impact on investors.
Does it help to understand market history to be prepared for the unexpected?One important thing knowing market history will tell you, for example, is that, on average, cash flows into any investment will tend to be most negative after returns have been most negative. In other words, when the stock market falls dramatically, investors tend to stop buying stocks or pull their money out of the market.
But you want to fight the urge to pull out of the market when it goes through a steep fall because some of the strongest periods of market returns come on the heels of very poor market performance. Market history will tell you that those who stick with their investing plan are well served by doing so.
What knowing market history will tell you is that to be successful as a long-term investor you have to be able to stomach volatility and years of underperformance.
How can you test your ability to stomach market volatility?One way would be to determine how your portfolio would have performed during 2008 and 2009, which was a very stressful period for the stock market, and how you would have reacted to it.
In more normal times, what is a reasonable way to deal with the market’s ups and downs?If you are concerned about market behavior something as simple as rebalancing at least annually may help. When you rebalance you are selling assets that have performed very well and buying those that have underperformed and may do better over time.
If you don’t rebalance, your portfolio may end up deviating significantly from where you’d like it to be. It’s important to ask yourself, “Am I still comfortable with how I have invested in stocks and bonds, and does that allocation meet my goals and objectives?”
One prediction that may be worrying savers is that the next decade will bring lower returns. How should they deal with that prospect?You can save more. Or you can take on more risk, meaning that you may want to invest more in stocks than in more conservative investments such as bonds.
If you hear that there is a third option, that you can get higher return without higher risk, run the other way.
Another way to think about returns is that when you adjust for lower levels of inflation expected returns are not as low as they seem.
I would take a 6% expected annual return on a portfolio with an inflation rate of 2% over a 10% expected return with an inflation rate of 7%. The first would result in a 4% real return, while the latter would result in a 3% real return.
All investing is subject to risk, including the possible loss of the money you invest.
Bond funds are subject to the risk that an issuer will fail to make payments on time, and that bond prices will decline because of rising interest rates or negative perceptions of an issuer’s ability to make payments.
Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.
These risks are especially high in emerging markets.