It’s been relatively smooth sailing in the stock market over the last year. That won’t last.
You would be wise to mentally prepare yourself for a market drop and the resulting losses it will inflict on your portfolio.
That isn’t a market forecast. I have no clue where the market is headed. It also doesn’t mean you should necessarily change anything in your portfolio. Trying to time the market is the surest way to end up with subpar returns over time.
I am merely recommending a simple trick that has helped me prepare for the ugly side of investing. And that means expecting losses from time to time.
Before I offer my simple trick, I want to explain why I think now is the right time to deploy it.
For starters, let’s review the annual market performance over the last few years. I am defining the market as the S&P 500, which is a basket of 500 of the largest companies in the U.S. Here are the total returns we have experienced in the past few calendar years:
2017 – 21.8%
2018 – (4.4%)
2019 – 31.5%
2020 – 18.4%
This year, through last Friday, the market is up another 23.9%.
The U.S. stock market is on a hot streak. But it can’t continue. The average market return since 1928 has been 9-10% annually. To get back to that average, the market is going to require a pullback.
On top of these stellar returns, we’ve enjoyed a relatively calm market, especially lately. So not only has the market gone up a lot, but it has also avoided big intermittent drops as it powered its way higher. These drops are common but have been conspicuously absent in the past year.
Since 1928, the market has seen intra-year sell-offs of 10% or worse in 63% of all years, sell-offs of 20% or worse in 26% of all years, and sell-offs of 30% or worse in 15% of all years.
In the past year, the biggest drop we’ve seen is just a hair over 5%. That won’t continue if history is any guide.
So, with that context, what’s my trick during these times? It couldn’t be any simpler. When you open your monthly or quarterly investment statements, find your total portfolio value. It probably looks a good deal higher than the year before. Multiply your total portfolio value by 90% or 80%. Then, forget your actual portfolio value and remember the number you calculated.
In short, take the perspective that some of your recent gains may be wiped out – for a period of time – in the future.
And that’s okay. You should not expect to see a higher number every time an account statement is issued. The market goes up, as we’ve seen, but it also goes down. We just haven’t seen that side lately.
Again, this isn’t a market call. For all I know, the market will chug higher over the next year or more. It’s impossible to forecast these things.
Fortunately, forecasting isn’t a required skill set to do well in investing. Maintaining a proper perspective is, however, and that includes anticipating losses.
Start preparing for such a stretch now. No one knows the hour or day, but the market has a knack for sneaking up on investors with nasty surprises when they least expect it.
Justin Lueger is President of Invisor Financial LLC, a registered investor adviser firm in the State of Kansas. All opinions expressed are his own and should not be viewed as individual advice. He can be reached at firstname.lastname@example.org.