The recent sharp decline in the stock market has investors concerned. Apparently, many "investment pros" thought the market would continue its upward trajectory through 2014. The National Association of Active Investment Managers conducts a weekly survey with advisers and found that they have an astounding 98.3 percent of their clients' portfolios allocated to stocks. This was a sharp increase over the average of 72 percent allocated to stocks in 2013.
Initially, I don't understand how any competent adviser could recommend an across-the-board allocation of 98.3 percent to stocks. Asset allocation should be based on the capacity of an investor to assume risk. Younger investors can afford to take more risk than those nearing retirement. Other factors to consider include your tolerance for risk and your needs at retirement.
Regardless of your exposure to stocks, a huge market correction can be extremely difficult on investors, but these tips can help you get through it:
Ignore the Financial Media
The financial media ravenously feed off a big drop in the market. You can expect lots of after-the-fact rationalizations by self-appointed "market pros" attempting to provide "insight and analysis" to the events of the day. As an example, David Lafferty, the chief market strategist for Natixis Global Asset Management, stated: "This is a convenient and healthy short-term pullback. The market really needs some time to digest last year's gains."
The reality is no one knows why the market fell, and no one knows whether it will continue to decline or promptly recover. Relying on the views of "experts" who attempt to make sense of random and unpredictable events is not an intelligent way to base your investment decisions.
Focus on the Long Term
I recently met with a 45-year-old lawyer. He told me he was very concerned about the market. I asked him why he invested. He said it was for his retirement. Here's the question I posed to him: Shouldn't your focus be on the value of your portfolio in 20 years?
Long-term data is not predictive, but it does put the daily gyrations of the market into perspective. According to Vanguard, the average annual return of a portfolio consisting of 60 percent stocks and 40 percent bonds for the period from 1926-2012 was 8.7 percent. The highest loss during that period was 26.6 percent in 1931. There were losses in 21 of the 87 years.
If you are preoccupied with short-term market volatility, you should not have any exposure to stocks. Investing is for the long term.
Ignore Short-Term Advice
The securities industry prospers when it persuades you to "do something." Trading generates transaction costs, which reduce returns. You should ignore this temptation.
"Doing something" is market timing. Bouncing in and out of the markets in anticipation of market movements is a failed investment strategy. The dismal performance of tactical asset allocation funds demonstrates this point. These funds attempt to beat their benchmarks by shifting their allocations based on the fund manager's assessment of what will likely happen in the future. Studies of the performance of these funds indicate the majority of them underperform the Vanguard Balanced Index Fund (VBINX), which simply tracks the performance of broad stock and bond indexes.
Focus on Factors You Can Control
There is plenty about investing you can't control, like the direction of the markets, interest rates and random events. You can control your asset allocation, fees, costs and taxes. If you don't have an investment plan, find an adviser who will prepare one for you and will give you the discipline to stick to it, in good times and bad. If you are invested in actively managed funds, switch to index or passively managed funds that have low management fees and are tax efficient. If you are not properly diversified (including exposure to international stocks and short-term, high-quality bonds), find an adviser who understands the benefit of broad diversification. If you are not discussing the tax efficiency of your investments with your broker or advisor, find someone who understands the importance of minimizing and deferring taxes.
These tips are action items you can implement today. Everything else is just noise in the channel, distracting you from achieving your investment goals.
Dan Solin is the director of investor advocacy for the BAM ALLIANCE and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His next book, The Smartest Sales Book You'll Ever Read, will be published March 3, 2014.
The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.