Corrections are accounted for in the comprehensive planning process

This year kicked off with a strong start for U.S. stocks, but then offered everyone a healthy reality check that markets don’t always go up. A spate of market volatility in February and then again in March tested some investors’ confidence in the equity markets, as well as their ability to stick with their long-term, comprehensive financial plan. It also dominated headlines in the financial media for weeks.

While no one knows exactly what caused February’s correction, explanations have ranged from worries about inflation and political factors to concerns that the Federal Reserve may get too aggressive with its interest rate hikes. Perhaps more puzzling, the S&P 500 Index and Dow Jones Industrial Average both entered correction territory in early 2018 amid a bevy of positive news on the economic front. In fact, estimates of future growth are on an upswing for economies across the globe.

This quarter has served as a reminder that market swings are inevitable, and no one can reliably time them.

Market volatility in perspective

In retrospect, February’s stock market correction was relatively contained. It didn’t feel that way at the time, though, coming over just a handful of days and following a remarkably tame and tranquil 2017. In reality, corrections — defined as a decline of 10 percent — are relatively common. They’ve occurred about once every two years in the S&P 500 going back to 1950. In each case, except for the most recent (at least so far), a bull market rally has completely erased the decline, often within weeks or months.

By the middle of March, the Dow Jones Industrial Average and the S&P 500 had both returned to roughly 5 percent off their end-of-January highs. However, some volatility has continued, especially after news of potential trade troubles with China, which briefly sunk markets back into or near correction levels. This quarter has served as a reminder that market swings are inevitable, and no one can reliably time them.

Yet the market does go up far more often than it goes down. According to The Motley Fool, for every day since 1950 that the S&P 500 has spent in a correction or bear market (defined as a drop of 20 percent or more), it has spent roughly three days in a bull market. Even so, in virtually every year from 1926 through 2017, there has been a period of time in which the U.S. stock market fell precipitously. Such intra-year declines don’t necessarily signal whether the market will be up or down over that given year, but they do show stock markets have been and always will be risky, particularly over shorter time frames.

Finally, it may help to recall that we have decades of data to help us understand the market’s long-term risks and expected returns. This allows us to incorporate risk into the way we build your financial plan, meaning events like the ones that occurred in February and March — however unpredictable they might be — already are accounted for in the comprehensive planning process. We believe (and an enormous amount of objectively vetted academic evidence confirms) that the best approach is a diversified, evidence-based portfolio structured to weather market fluctuations.

The spectre of rising interest rates

In late March, the Fed raised interest rates for the first time with Chairman Jerome Powell at the helm. It was the sixth increase since December 2015, and the federal funds rate — which helps determine interest rates for mortgages, credit cards and other types of borrowing — climbed a quarter of a percentage point to a range of 1.5 percent to 1.75 percent (still extremely low by historical standards). Additionally, the Fed stuck to its previously established target of three total rate hikes in 2018, which reinforced the impression that it will maintain a gradual approach.

Many, however, still worry about how rising interest rates could impact their bond portfolios. In short, the market value of a bond purchased now, at current interest rates, will fall if interest rates rise in the future. (Keep in mind, though, that an investor buying a bond in the future, at that higher interest rate, should benefit from higher returns based on the better rate.)

But that fails to capture the full picture. For instance, it’s certainly no secret that the Fed is planning to increase interest rates. As a result, the markets have already priced in that information, which is reflected in the current yield curve. What matters is whether interest rates increase faster or more than already expected. Unfortunately, like with stocks, the evidence shows that trying to outguess the market when it comes to interest rates is a losing proposition. Put simply, the collective wisdom of the market is a very tough competitor.

The prudent strategy, rather, is to construct a bond portfolio with an average maturity that balances the various risks (including interest rate changes and inflation) associated with fixed income investing. Accordingly, the equity, bond and alternative asset portions of each individual client’s overall portfolio are determined based on his/her willingness, ability and need to take risk in relation to long-term goals and objectives.

Remember, the evidence shows there are no good forecasters, and too many have a dismal track record when it comes to accuracy. Your best option is to ignore the news and the predictions in it. Instead, stay focused on your long-term goals and what’s truly important in your life and in the lives of those around you.