How do you prepare yourself for a stock market crash?
- Take steps to avoid the investor return gap.
- Integrate tax planning into your investment strategy.
- Consistently manage your risk levels.
Did you know that most investors don’t come close to capturing the returns the market offers? According to Dalbar, Inc., an investor research firm, investors badly lag the amount returned by the average index fund.
Here’s an example:
Investors are leaving half of their returns on the table. The best example can be demonstrated by examining the returns of the largest retail mutual fund, the Vanguard S&P 500 Investor class. Investors in this fund underperformed the S&P 500 by an annual margin of -4.42% during the last 10 years. While the broader market made annual gains of 8.37%, the average equity investor earned only 3.95%.
Similarly, investors in bond funds are lagging. The best example here is the Pimco Income fund. According to Global View’s analysis of year-end data from 2017 reported to Morningstar, even savvy investors (purchasing one of the best funds in the category) in the R class (offered in many retirement plans) underperformed the mutual fund by -3.37% annually. The fund did exceptionally well making 8.45% annually, but investors made only 5.08% annually.
As you can see, the average investor captured only a portion of the market return.
Why Does This Gap Consistently Occur?
Using low-cost index funds doesn’t prevent people from falling victim to their emotions. This means they buy more after things have run up and feel “safe.” And they tend to panic at market lows and sell at the worst time.
Truly, we are our own worst enemies. At least when it comes to investing.
How Can We Break This Cycle?
Educate yourself on market cycles and behavioral economics, including the principles of persuasion. It’s possible to control these behaviors, but it does take time, commitment and discipline. It’s not easy. Even professionals have problems when managing their own money.
Use a professional to help guide your investment decisions. Having an advisor who will be your advocate (instead of a salesman) can help you avoid these expensive mistakes. When the markets get frothy, they can help you avoid overinvesting in what appears to be the “sure thing” everyone is talking about. When markets get scary (remember the global financial crisis), an experienced professional who has studied and understands market cycles can help you avoid these common panic-selling behaviors.
At Global View, our advisors serve as that key advocate for our clients. This way, they can feel more relaxed that they have help in determining the best times to buy or sell investments. By helping them capture more of the market returns, we can help their money work harder for them.
Whatever you do, it is vital that you take action to avoid taking big losses. Think back to the dot-com era or to 2008, more recently. Many retirements were postponed because people experienced large losses. It is vital that you avoid those big losses, especially with money you can’t easily make back.
It’s too much to detail here, but the process begins with setting expectations. The first step for that is gaining a valid understanding of your true tolerance to risk.
Accountants are many investors’ unsung heroes. A diligent accountant can help you in ways you would never imagine on your own. Making sure you save for retirement and that you take advantage of smart tax deferral strategies is one of the most important things an investor can do. Unfortunately, in their zeal to minimize taxes, they can sometimes take their eye off the ball, which is to maximize your total wealth (after taxes).
In their zeal to minimize taxes (and sometimes to ease tax preparation), accountants may overlook serious investor pitfalls such as:
- Using high-cost insurance or variable annuities to avoid taxes (but to incur substantial fees and thereby reduce wealth to heirs). Sadly, some accountants recommend or even sell them.
- Asking investors to avoid investments because they can make tax preparation more difficult. For example, accountants often recommend investors avoid owning investments that may generate K-1s. But for some investors (seeking to avoid capital gains for example), these can make sense. Removing limited partnerships from our stock model reduces its performance by more than 1 percent annually.
- Wrongly focusing on investment fees because they don’t understand the Investor Return Gap and the cost of hidden fees. Vanguard and Morningstar both believe investor coaching and asset allocation can easily add back the cost of advice. This means, for most investors, a true fee-only fiduciary advisor is worth the fee, even if he doesn’t add value on investments.
- Understanding your risk tolerance. Few advisors do this right. And it’s just not in an accountant’s tool kit. Understanding what to expect can literally be the difference between weathering the storm and making an irreversible decision to destroy wealth!
- Being unwilling to pay taxes on gains (when necessary to reduce overall portfolio risk).
Smart investors understand markets don’t go up in a straight line. They also understand periods of over-performance are often followed by periods of lower returns. They might not know what current valuation levels imply. In a nutshell, they imply lackluster returns for U.S. equities and bonds. Investors might do substantially better looking overseas and in emerging markets and thinking outside the box about bonds.
Smart investors need to understand that looking globally for opportunities (in equity and fixed income) may not only increase return but can reduce risk. And that by doing so, they can increase their odds of achieving the goal they seek.
If your assets are in a retirement plan, you can rebalance with impunity (you don’t have to pay taxes). But if you, like many of our clients, also have substantial assets outside of IRAs and 401ks, then it might be time to bite the bullet and tax some gains.
At Global View, we have an in-house accountant that works with our investment managers to make sure you can identify and take advantage of these great opportunities when you can get more return without taking unnecessary risk.
These strategies will prove their worth in the next market downturn.
Risk is a confusing topic. Once you have money you know one thing: You don’t want to lose it. Sounds straightforward, but many investors commonly get caught in bad situations. That’s when they fall victim to the confusopoly!
To avoid this, you have to have an experiential understanding of risk!
We see the same stories play out over and over. New clients come in thinking they are diversified. Nearly every working client we help retire is taking much more risk than they should. Many of them think they are “low risk” because they are invested in U.S. stocks they know. Because they haven’t seen their investments fall in half (like U.S. stocks did twice in the last 20 years), they think that’s safe.
Sometimes investors inherit portfolios. These too may be all stocks. That may have been appropriate for Grandad, who knew the companies well, but now that it is your money, it should be treated like yours.
If U.S. stocks keep going up, there’s no problem. But history tells us that never happens. Stocks go up and down (they revert to long-term mean). When they go down next time, you don’t want to get caught unprepared.
No one has a crystal ball. While “expert” forecasters are all over the financial media, these “experts” are no more accurate than a coin toss. Once you have serious money, you can’t afford to leave your wealth to chance.
Whatever you do, remember, no one will watch your money like you do. You must stay engaged:
- Watch your professionals, even the ones you trust. It’s your money and no one cares as much about it as you do. Don’t fall victim to the confusopoly!
- Keep tabs on what your advisors are doing. Communicate often. Don’t assume anything. Always ask.
I don’t want you to be a confusopoly victim.
