(Reprinted from the October 2015
edition of the Bath Country Journal and Richfield Times.)
Global markets have been providing
investors a rough ride. While falling markets can be worrisome,
maintaining a longer-term perspective makes the volatility easier
to handle.
A typical response to unsettling
markets is an emotional one. We quit risky assets when prices are
down and wait for more “certainty.” Consciously or not,
we try to time markets and thereby attempt to predict the
future.
These timing strategies can take a
many forms. One is to use market technical indicators to get out
when the market is judged as “overbought” and then to
buy back in when the signals tell you it is “oversold.”
A second strategy might be an economic one – for example,
undertake a comprehensive macro-economic analysis of the Chinese
economy, its monetary policy, global trade and investment linkages,
and how the various scenarios around these issues might play out in
global markets.
In the first instance, there is
little evidence that these indicator-based timing decisions work
with any consistency. In the second instance, you can be the
world’s best economist and make an accurate assessment of the
growth trajectory of China, together with the policy response.
Nevertheless, that still does not mean the markets will react as
you assume. An illustration in absurdity: according to a Vanguard
study, rainfall has historically actually a better predictor of
future stock returns than GDP growth.
Another way is to reflect on how
markets price risk. Over the long term, we know there is a return
on capital. However, those returns are rarely delivered in an even
pattern. There are periods when markets fall precipitously and
others when they rise inexorably. The only way of getting that
“average” return is to go with the flow. Think about it
this way: a sign at the river’s edge reads, “Average
depth three feet.” Reading the sign, the hiker thinks:
“OK, I can wade across.” Yet, he soon discovers the
“average” masks a range of everything from 6 inches to
15 feet.
Historical market returns are often
thought of as offering “average” returns of 8% to 10%.
Yet, individual year returns can be many multiples of that average
in either direction. Understanding possible outcomes from your
investment choices helps set proper expectations.

For example, look at a global stock market
benchmark such as the MSCI World Index. In the 45 years from 1970
to 2014, the index has registered annual gains of as high as 41.9%
(in 1986) and losses of as much as 40.7% (2008). However, over that
full period, the index delivered an annualized rate of return of
8.9%. To earn that return, you had to remain fully invested, taking
the unsettling down periods with the heartening up markets, but
also rebalancing each year to your target asset allocation.
Timing your exit and entry
successfully is a tough task. In 2008, the index had the worst
single year in our sample, yet, in the following year, registered
one of its best ever gains.
What has happened is already priced
in. What happens next is what we do not know, so we diversify and
spread our risk. For instance, while stocks have been performing
poorly, bonds and managed futures have been doing well.
Markets are constantly adjusting to
news. A fall in prices means investors are collectively demanding
an additional return for the risk of owning equities. For
individual investors, the recent price decline may only matter if
they need the money today. Even for a retiree, not all of their
accumulated capital is needed for today and some market risk
generally must be assumed to outpace inflation and maintain
purchasing power over time.
Kevin Kroskey, CFP®, MBA is
President of True Wealth Design, an independent investment advisory
and financial planning firm that assists individuals and families
with their overall wealth management, including retirement
planning, tax planning and investment management needs.