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Keep a Steady Hand on the Tiller

Keep a Steady Hand on the Tiller

Sticking to a disciplined plan is the key to investment success

Over this past week, and again today, you’ve probably seen and heard quite a few market headlines that raise concerns among your clients.  The following are some examples:

“If your pension, retirement savings or 401k is invested in the stock market, you lost big today.”

“The stock market drops 530 points and more than 1000 points for the week.”

“The Dow Jones Industrial Average plunged as much as 1,089 points shortly after the open, marking the index’s largest one-day point decline ever on an intraday basis.”

First, remember that the financial media thrives by writing colorful headlines, which draw eyeballs and hence sell advertising. As I posted on Twitter this morning before the market opened, “What goes up today?  CNBC ad revenue.”

It’s been a crazy few weeks for investors though, and if your clients are asking questions, the following are a few points that might help.

Advice for Clients

1. Keep calm and stay on course. The best advice might have come from my 10-year-old son, Jack, when last Friday night (the day of the 530 point drop in the stock market), he told me about his day on the water in sailing class. He said, “Daddy, today the wind was strong and it was a little scary at first. I remembered what my teachers said though, kept calm and just stayed on course.”

Staying composed when storm clouds bring bad weather isn’t easy but, just as keeping a steady hand on the tiller and staying calm is the key to reaching a port safely, avoiding the urge to make changes in volatile markets is the key to long-term investing success.

2. Have a long-term plan. Make sure your client has a solid long-term plan (emphasis on long-term) that’s prudently diversified and designed to meet their goals, not the investment models of others.

I know it’s hard to avoid getting emotionally drawn in by market headlines, but try to remember that investing should be a means to an end, not a competition.

Over the years, I’ve written many commentary pieces after market falls (it seems that concerns over 50-year floods come every five years or so in the stock market) and my message is always the same.

Try to stay anchored on your plan versus getting caught up in the day-to-day.

This is very difficult, by the way, and many investors make poor decisions at the wrong time.

Earlier this year, Morningstar published a report that looked at the difference between the average return of mutual funds and the actual returns of investors.  According to their research, the 10-year return of the average U.S. equity fund for the period ending Dec. 31, 2013 was 8.18 percent.  What was the average return of U.S equity fund investors over this same time period?  Unfortunately, only 6.52 percent.

If you believe that this 10-year period was an outlier, you can look at research from the institutional investment consultant DALBAR.  The findings showed that investors have underperformed the market by approximately 4.2 percent per year over the past 20 years (See “Bad Decisions Persist After Decades of Education and Disclosures” to read the full whitepaper).

Help Clients be Better Investors

What can our clients do to be better investors?

If they don’t already have a written investment policy statement (IPS) or long-term plan, they should consider getting one.

An IPS should set long-term targets for various asset classes and maximum and minimum risk control ranges around the targets.  This way, regardless of the emotion of the market, your client can keep himself from making big bets that can turn into big mistakes.

For example, a moderately risk-adverse client might consider having a long-term target of 60 percent in equities with a low-end range of 50 percent and a high-end range of 70 percent.  If the market drops significantly and the equity allocation goes below the minimum range, the IPS mandates that an investor buy.  On the other hand, if the market has run up significantly, the maximum IPS ceiling forces selling to take some chips off the table.

I certainly don’t know how this current market will unfold over the next few weeks or months, but sticking to a disciplined plan is the key to investment success.  The old saying is, “Strategies don’t blow up, people do.”

Beyond the Morningstar or DALBAR research mentioned above, one of the best examples of potentially lost opportunities might be from the 2008-2009 financial crisis. In March 2009 the S&P 500 hit the “world is going to end” level of 666.  If your client had an IPS in place, and someone to help them stick to his written plan (it’s hard to keep emotions in check on your own), your client would have found himself below his minimum allocation target to equities and would then have bought equities at the end of the quarter to rebalance back to their long-term target.

Even after what the financial press is currently calling “a rout,” (DJIA down another 588 points today), the S&P 500 closed on Monday at 1,893. A gain of over 184 percent from the 666 low in 2009.

We’re currently experiencing some market storms, but remember, history consistently teaches us that true long-term investors (who will in practice come in for the most criticism – John Maynard Keynes) are rewarded for keeping a steady hand on the tiller.

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