DEAR PRUDENCE
“Prudence is that virtue by which we discern what is proper to be done under the various circumstances of time and place.”
– John Milton
What does prudence require in light of the circumstances investors faced in the first six months of this year? And there is no sugarcoating those circumstances: this has been one of the worst first half years in market history. As of June 30, the S&P 500 was down -21%. The Bloomberg U.S. Aggregate Bond Index, a measure of the broad U.S. bond market, was down -11%.
Since its founding in 1982, PMA has always endorsed the benefits of long-term investing and the necessity of staying the course during negative markets such as the painful one we are now experiencing. We think that long-term returns are really the only ones that matter for a successful investment plan. And we have always counseled clients to avoid making short-term, impulsive investment decisions, particularly when understandably rattled by a volatile bear market.
However, these ideas, though prudent, wise and true, suddenly seem less convincing when confronted with the stark reality of a bear market. The truth is that all of us live in the short-term, and sometimes the short-term can be tough to endure, like during the months of January through June of 2022.
We know what our clients are feeling right now because we are feeling it as investors ourselves, too. For those of us invested in the financial markets, there is a uniquely painful form of helplessness and anxiety that we experience as we live through a market like this year. Few things compare to that feeling you get when you check your account balance and discover that your holdings are worth significantly less than they were six months ago.
Seeing your $2,000,000 account fall 5% to $1,900,000 is unpleasant but manageable, but when the 5% decline turns to 10%, and the value of your account is now $1,800,000, you start to ask yourself – “this can’t get any worse, can it?” Your question is answered when the 10% decline becomes a 15% decline, and you look in disbelief: your account is at $1,700,000, a fall of $300,000 in less time than it takes – in this age of supply chain chaos – for a new couch to be delivered.
At this point, as rational human beings, we start to question everything. The sense of helplessness and anxiety increases and we naturally want to alleviate these feelings. We rightly wonder, as we see our net worth decline, “am I supposed to just watch this?” Isn’t “there something I should do?”
Unlike some other investment management firms, the bias of PMA is towards non-action as it relates to investments. Too often, we are our own worst enemy, and we agree with the words of Vanguard founder, the late Jack Bogle, who famously counseled investors during painful markets to follow this mantra: “Don’t do something; just stand there.” Or, in the more academic words of Warren Buffet’s partner Charlie Munger, being able “to react with equanimity” to large equity declines is “in the nature of long-term shareholding.”
This doesn’t mean there is truly nothing to do, but there are plenty of actions you can take that, though understandable given the context, will hurt your long-term wealth. But other actions, though difficult in the short-run, are sensible and will help you in the long-run.
Let’s look at some of these choices, starting with the worst choices first.
Sell to cash
The most natural and human of all the possible actions to take in response to your seeing your money fall, this is also the worst. As long as you do not sell, your losses are paper losses only; they are not realized losses. The only way to make those losses permanent and irreversible is to sell after your assets have declined in value.
Time the market
Selling to cash is a close cousin to another bad idea, but also a very human one – trying to time the market. Investors think to themselves: “I can get out now and I can always get back in when the market starts to go up again.” What frequently happens is they sell at a low point of the market, and then miss the majority of the rebound. Or, they buy at the first sign of a market upturn, only to find themselves fooled by the markets when another 10% correction occurs.
Lower your risk
Although we generally do not advise clients to change the risk of their portfolio in response to market downturns, nothing teaches us more about our true capacity to stomach a bear market than living through one. We encourage you to reflect on how you have reacted to this downturn. As we age, our attitude towards risk can change, and the level of risk we were comfortable with fifteen years ago may no longer match our temperament. If this applies to you, we recommend you meet with us to discuss how and when to reduce your allocation.
Spend less from your portfolio
Bear markets are most difficult for people who have retired and are using their assets to support themselves. There is a substantial body of research in finance and financial planning supporting the idea that one of the best ways to respond to volatility in the market is by adjusting your spending, not your portfolio. Just as you can reward yourself when the market is up, so should you consider lowering your spending, if possible, in response to a significant market decline. Having this flexibility – this option – will increase the longevity of your portfolio during retirement.
Invest more into your portfolio
If you are still five or ten years away from retirement and have some extra cash that you have been wondering what to do with, this bear market is actually a blessing, as hard as that may be to believe in today’s climate. The best thing you can do is SAVE. Put that money to work while stocks are less expensive than they were six months ago.
Get some perspective
Gains in our portfolios take place over the long-term and are not as acutely felt as losses, which often happen more quickly and make a much more searing and dramatic imprint on our brain. We remember the 20% loss of the S&P 500 over the first six months of 2022 and forget its cumulative return of 433% since July 1, 2009. Even if our investment horizon stretches back only three years to July of 2019, the S&P 500 still had an average return of 10.6% per year. It may seem contradictory, but even as we recommend you do not check your account balance too frequently, this now may be the time to go back and look at some old statements to get some perspective on how far you have come.
Ask your Advisor – What have you been doing?
PMA has also been weighing various actions to take in response to this market environment. First, back in the fall of 2021, in response to the signs of rising inflation, we made the first in a series of investments in a TIPS (“Treasury Inflation-Protected Securities”) fund, which is designed to act as a hedge against inflation risk. Second, also in response to the threat of higher inflation (and interest rates), we reduced the duration of our clients’ bond portfolios, an action which makes the bond portfolio less sensitive to changes in interest rates. Third, in response to the historically wide valuation gap between growth stocks and value stocks, we have been slightly shifting assets from growth to value. Fourth, we have been evaluating and acting on tax-loss selling opportunities in taxable accounts to help reduce your tax bill next April. And fifth, we have been rebalancing client portfolios if the allocation has strayed too far from its target.
Finally, we would encourage you to contact us at any point for any reason, especially during times like this. We come to work every day with the goal of helping our clients. We cannot move markets, of course, and we do not make big moves. Action has its virtues, but so does prudence. It depends on the context and the activity. Getting the balance is not easy and it is not even clear what should be the correct ratio between the two. We try to find that balance. We have been reaching out to many of you during this time, but if we have not spoken to you yet, please contact us. We want to hear from you.
