Importance of Keeping Perspective by Jack Moller, CFP®Submitted by Moller Financial Services on October 28th, 2022
Importance of Keeping Perspective by Jack Moller, CFP®
Perspective - the capacity to view things in their true relations or relative importance
Before writing this post, I looked up Webster’s online dictionary and, among others, found the above definition for the word “perspective”. And, honestly, as I recently “celebrated” my 65th birthday, I’ve been thinking more and more about perspective. In particular, 65 is the age when we become Medicare-eligible. For years, since I started Moller Financial in 1991, I’ve been telling clients that the 65th is one “older” birthday that is a good one … at least financially with Medicare. I’m realizing now that it feels much different than it did talking about it when I was decades away. In so many ways, this has been a pivotal birthday for me but not for the Medicare reasons. First of all, I’m feeling much, much more grateful to be here to celebrate as I realize my mortality to a much greater degree. In fact, while I’ve been fortunate to have good health at this stage in my life, I’ve recently gone through a couple scary moments – being hit by a car while I was riding my bike and just a few days ago missing a bottom step and tumbling into the wall. Fortunately, both were just minor bruising and my head was spared. But, … I realized that I was fortunate as both weren’t too far from being much more serious! (As an aside, when I fell on the stairs I was alone in the house and my Apple Watch detected my fall and offered immediately to call for help. That’s a nice feature!)
Speaking of perspective, that is one long paragraph on “me”. Sorry about that. Yet, I think in aging we can really see what a different perspective can look like. For example, as we age, we start to trade off the need to be “smart” and knowledgeable for the wisdom gained from our life experiences of successes and failures. With this wisdom, we start to see truths below and beyond facts. Interestingly, we generally have a choice in what perspective we want to take. And, these choices can and do often dictate our emotions, thoughts, moods, etc.
Investing Perspectives – Should We Be Wringing Our Hands or Clapping Our Hands?
So how do we want to look at the sharp declines in markets this year? You may not be surprised to know that I’m leaning toward hand clapping as opposed to hand wringing.
We all know this has been a brutal year in the markets driven primarily by the Federal Reserve (and other central banks around the world) aggressively hiking interest rates to combat the highest inflation rates that we have seen in ~40 years. In fact, this has been the “worst” year for the bond market in terms of price decline in history. At the same time, the stock market is in the midst of a somewhat drawn-out bear market with most indexes having fallen over 20% from their highs earlier in the year and with the tech-heavy NASDAQ and small-cap Russell 2000 having dipped over 30% at the year’s lowest levels. (I should note that both stocks and bonds are bouncing a bit as I write this.) It is relatively unusual to have both markets head sharply lower at the same time, affording no real safe havens besides cash. In fact, the classic, balanced (i.e. conservative) portfolio of 60% stocks and 40% bonds (depending on what benchmarks we use) is having its second worst year in history and the worst since the 1930s.
It hasn’t been fun, to say the least, but let’s take a step back to get some perspective.
The Fixed Income Market
As noted above, this year has seen a huge price decline in all areas of the fixed income market. Holders of longer-term bonds (10-year to 30-year maturities) have seen declines even worse than the stock market! Stepping back, remember that bond prices move in the opposite direction as their yields. When yields start at 0% (or generally at unprecedentedly low levels), interest rate increases from that low of a base represent huge percentage moves and thus huge price declines. As I write this, yields on Treasury securities have jumped so that virtually the entire Treasury market from 3-month to 30-year maturities are all yielding between 4% and 5%. We haven’t seen rates this high in over a decade.
Truthfully, I believe that, in the long run, this is a very good thing for investors. Finally getting decent returns in these safe investments (safe in terms of returning principal at maturity) will allow a more traditional portfolio to work as it historically has in generating income from the bonds with growth from the stocks. For years, rates have been so low that the risk-free returns of short-term Treasury bills had been euphemistically recharacterized as “return-free risk”. More importantly, the vanishing yields had forced investors into the stock market. While that may be okay for younger investors, those in retirement who needed the security and steady income of a more conservative portfolio were forced to take on much more risk than appropriate.
Truthfully, I am “clapping” for these higher rates, but I would also be happy to see the Fed ease off so that the rates could settle in without causing too much more short-term pain. Looking at a couple of investment approaches, we can see how these higher rates will gradually benefit the long-term investor:
- Bond Ladder. In this strategy, we own bonds spread across various maturities, e.g. having one bond mature each year for 10 years. When the yearly maturity occurs, the proceeds are simply invested in another 10-year bond to keep the once-a-year strategy out to 10 years. Finally, after a long drought, we will now be able start filling the ladder with decent yields, improving our long-term returns.
- Bond Funds. One reason to invest in a bond fund is to take advantage of the inherent benefits of diversification and liquidity. Furthermore, these funds tend to generate regular income via coupon payments that are now being reinvested at likely much higher rates. Again, the long-term returns improve.
Going back to my theme of perspective, this is really a case of time frame. While the short-term pain is high, the long-term benefits clearly outweigh the temporary pain for multi-year, investing timeframes.
The Stock Market
Most U.S. stock market indexes recorded all-time record highs during the first week of 2022. Since then, with the aggressive Fed continuing to execute very substantial rate hikes every couple months or so, most stocks have taken it on the chin. As noted above, particularly hard-hit have been the large tech-related stocks as well as the somewhat more speculative smaller company stocks. As some of the behemoths that shined during Covid have been particularly hard hit, the major indexes most represented by these companies (NASDAQ and S&P 500) have experienced precipitous declines. My guess is that the short-term “investor” driven by emotions has unfortunately likely loaded up on the big names and has felt immense pain and fear with the market’s weakness.
My “hand clapping” perspective for stocks is somewhat analogous to the bond case. If we think of total return instead of yield, we can see that this sell-off is providing us with the opportunity to achieve improved returns over time. The total return on stocks comprises a combination of appreciation plus dividend payments. By many measures, valuations at the start of the year were at all-time highs and dividends were comparatively low, in sync with rock bottom interest rates. Thus, both expected appreciation and anticipated income was likely to be limited for a while. Now, these lower prices likely present greater appreciation potential and higher dividend yields.
Long-Term Investors Need to Keep Short-Term Gyrations in Perspective
With the insight that our investment portfolios are structured to allow us to achieve our long-term financial goals, we successful investors see these periodic downdrafts as inevitable and necessary to endure in order to achieve superior long-term growth and the life we desire. We know that the price markdowns are evidence of both stocks and bonds being on sale! Might they get marked down some more? Sure, but current prices are starting to look more attractive. In fact, in the 60-40 conservative, balanced portfolio, both sides (stocks and bonds) are on sale at the same time. A very unusual opportunity!
I urge you to never forget that short-term declines are temporary and the long-term appreciation is inevitable! Try to keep clapping and, at a minimum, avoid panic while staying the course.