3Q 2014 Market Review Recap

November 07, 2014

The editorial mission of the Fiduciary Advisor blog, and all of our FFP University publications, is to help investors translate the latest market news from a fiduciary perspective - putting their needs first on an active basis. Our quarterly market review webinars are a big part of that. We know that many of our clients don't have time to view the recent Q3 Market Review webinar, so I'll summarize the key points here. And we'll try to do this every quarter to help you break through the market noise and stay focused on your financial plan.

The certainty principle

A frequent complaint we get from would-be investors is that uncertainty is what keeps them out of the markets. "I'll stay in cash until the direction of the market becomes clearer," they say. Alternatively, for those already invested, they nervously eye media commentary about possible market pullbacks and say, "Maybe now is a good time to move to the sidelines and wait for the uncertainty to pass."

When has there ever been total certainty? There is always something to fret about. The fact is that there are always events happening and pundits are always spewing a broad range of views about the likely outcomes. The big question for the rest of us is what to do with all this market noise. One approach is to debate the implications of market news and try to anticipate what might happen next - timing the market. But whom do you believe? There are always compelling arguments for multiple scenarios.

Our investment approach is much simpler. It begins by accepting market prices as a fair reflection of the collective opinions of millions of market participants. So rather than betting against the market, you work with it. That means building a diversified portfolio around the known dimensions of expected returns according to your needs and appetite for risk defined in your financial plan - not according to the opinions of market pundits. It also means staying disciplined and sticking to your chosen asset allocation strategy and rebalancing your portfolio from time to time. The trigger for rebalancing is not media speculation - it's the need to maintain your desired asset allocation. Of course this does not mean you cannot take an interest in global events. But it does spare you from basing your long-term investment strategy on the illusion that somewhere, at some time, "certainty" will return.

Volatility returns - again

The 3rd quarter was relatively flat for US stocks. Overseas markets got beat up. The dollar is getting stronger. Bond interest rates declined recently to the surprise of many, so bond values rose. The story early in Q4 seems like it's the return of eurozone crisis. Global growth is slowing down. What might be happening is the Fed is likely to raise rates in the middle of next year. If you look at Fed tightening cycles historically, six months or so ahead of that you always get a lot of market volatility.

We talk a lot about risk, which we define in terms of volatility. And that's where having a financial plan that deals with current spending and debt service is essential. A lot of people went bankrupt during the last financial crisis just because they didn't do this analysis and planning work. The volatility we've been seeing reemerge recently is not an unusual thing. We looked at some data recently going back to 2000-2012 - 156 months - and asked how many of those months were up or down 6% or more. About 30%. That's a big number. What's actually unusual about the last 18 months or so has been the lack of volatility in markets. So maybe we've gotten spoiled. Stocks pullback 20% every three or four years. The last time this happened was the euro crisis of 2011. Market volatility is inevitable.

Global diversification & retirement cash flow

Proper asset allocation is critical to growing and protecting your money. Towards the end of the webinar, we reviewed the performance of various portfolio combinations of stocks and Treasury bills. With stocks not far from all-time highs - and outperforming bonds and cash over long periods - it's no surprise that allocations with higher proportions of stocks have higher returns. However, the years 2000 and 2008 strike fear into many investors, especially retirees and those approaching retirement. It is important to make your allocation decisions based on your time horizon, risk tolerance and overall financial plan context - rather than fear or greed.

How do we balance the need for growth or inflation protection with the need for conserving our portfolios for what may be a very long period of retirement? The key is cash flow, and that is what drives our individualized analyses for our clients. Markets will increase in value over time, but not without significant fluctuations. However, if your cash flow from income sources and relatively safe investments can sustain you through stock market downturns, then you are positioned to take advantage of the long-term growth in stock markets that can support and sustain your goals for as long as you live.

Single most important takeaway - discipline

The bottom line? Follow a prudent financial planning process to understand where you stand vs. your goals, build your portfolio around that and make financial decisions in a disciplined way according to that strategy. Assuming you've done the planning work, just stay the course. The plan for volatility, when it inevitably shows up, is usually simple portfolio rebalancing. For example, in a 60/40 asset allocation, selling off some stocks if they rise and buying bonds to maintain that 60/40 balance.

If you don't have a solid fiduciary financial plan that you're confident puts your needs first, it's never too late to start. View our Fiduciary Financial Planning webinar to learn more or contact us to discuss ways to get started.

To keep in the loop on every Fiduciary Advisor blog post as it's published, sign-up for blog post email alerts.