The Importance of Risk Tolerance & Financial Planning in Unpredictable Markets

The Importance of Risk Tolerance & Financial Planning in Unpredictable Markets

What a quarter. What a year, for that matter. This is probably the worst market behavior I’ve seen in my (admittedly short) career. Every time some good news emerges, the market tries to stage a halfhearted rally before resuming its drop. Even we, investment professionals and CFA charterholders, are starting to feel a bit downtrodden, resigned to living in “the house of pain” (a phrase I’m stealing from Jim Cramer) for awhile longer. All the charts, graphs, ratios, and data in the world can’t prevent a market from behaving irrationally, nor can they predict that behavior. 

“Boy, there’s a bleak picture,” you say. “If that’s how you feel, why don’t we just sell everything and hold onto cash until things start to look better?” you ask. And you’re not alone; we’re asked this question (or a version of it) all the time, and there are a lot of different answers we can give to explain why we believe that such a strategy is ineffective. Here are some of my favorite statistics and comments on the subject:

  1. Since 1946, the S&P 500 has experienced a pullback of 5-10% nearly every year. On average, pullbacks require about 2 months to recover. (we’re past this point now)
  2. Corrections of 10-20% happen every few years, with an average peak-to-trough loss of 15%. They usually last about 5 months and require about 4 months to return to breakeven. (we might be here)
  3. Bear markets with losses of 20-40% have occurred 9 times since 1946, requiring about 14 months on average to recover. (we’re not here yet)
  4. The moral of points 1-3: if you can’t stay invested for 14 months, you probably shouldn’t be invested at all.
  5. Missing the market’s best days has a significant detrimental impact on your portfolio, and there aren’t very many of them. Nejat Seyhun, a professor at University of Michigan, analyzed market returns from 1963 to 1993 and determined that, “just 90 days generated 95% of all the years’ market gains — an average of just three days per year.”
  6. Josh Brown, a financial advisor with Ritholtz Wealth Management and a prolific blogger known as “The Reformed Broker,” reminds us that, “there’s never been a stock market crash that the Dow hasn’t recovered from.” A simple point, but a powerful one.

This is why we feel risk tolerance and financial planning are such vital components of the investment process. If we can make investment decisions according to each client’s unique timeline, goals, and ability to stomach the roller-coaster, we can minimize the probability that market declines hamper that individual’s financial future. The market has always been volatile and it will likely always be volatile. The causes of the volatility are constantly changing, but like a bad action movie, the plot follows the same formula. Despite what the media may say, there’s no reason to believe this time is any different. 

Source: thereformedbroker.com/2013/11/12/everything-you-need-to-know-about-stock-market-crashes/

Source: www.aaii.com/journal/article/stock-market-retreats-and-recoveries.touch

Source: www.ifa.com/12steps/step4/missing_the_best_and_worst_days/

Benjamin Sadtler, CFA

The above article is for informational and educational purposes only. Neither the information presented nor any opinion expressed constitutes a recommendation or endorsement by Gore Capital Management nor Cantella & Co., Inc. of a specific investment or the purchase or sale of any securities.

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