Keeping Perspective After a Painful Year, Easier Said Than Done
At this time last year, we wrote the following: “As we say goodbye to the year 2021, perhaps the best that can be said about it is that it wasn’t as bad as 2020. Faint praise, true, but at least we may be trending in the right direction.”
Although it’s easy to look back in time and – with 20-20 hindsight – poke fun at our blind spots and the sometimes sheer absurdity of life, reading that statement now makes us marvel at our own limitations.
2020 and 2021 were bad years? The S&P 500 was up 18.4% and 28.7%. The S&P 500 return for 2022: -18.1%. As for the phrase – “at least we may be trending in the right direction” – well, the less said the better. There is a reason why this firm was founded on the idea that no one can predict the short-term future returns of financial markets.
We thought we knew bad years. Now that we have been reminded of what a really bad year looks like, we say goodbye and good riddance to the year. And, inverting the words of Abraham Lincoln, we say goodbye to 2022 with malice and no charity toward it. At least we had the Phillies.
In fairness to us, and to you, there is more to life than the returns of the S&P 500, as these last three pandemic impacted years so vividly illustrated. Judging them solely on the basis of their year-end financial returns, 2020 and 2021 were good years, but they sure felt awful. When you include 2022, the last three years have been exhausting. The pandemic loomed over everything; the markets dropped precipitously during the scary days of March 2020; anger and division characterized the country’s mood; overseas, a brutal war erupted in Eastern Europe.
Being an investment advisor can be a humbling experience. The world is a complicated place. We cannot control the markets or predict the future. We seek to diversify and manage risk. And even though we think we did our job in 2022 – our decision to keep our bond portfolio’s maturity short helped cushion the fall in bond prices – it is painful for us to see any client suffer a decline in their assets.
In addition to the actions we took, we also tried to communicate with our clients and help give some perspective on this year. This, too, can be a humbling experience. First, we reiterated this advice:
stay the course,
don’t time the markets,
long-run returns are the only ones that matter,
choose an asset allocation you are comfortable with and stick with it
These are good words and we stand by them. But we recognize that even words of wisdom do not sooth the feelings we experience when we see the value of holdings decline.
Take the phrase “long-run returns are the only ones that matter.” When we speak of long-run returns, we typically mean 10 or more years in the future. Therefore, the time period of 2020 through 2022 was a short-term, non-material period of time for investment purposes. But does this period feel short? For most of us, 2020 seems like a lifetime ago. How we experience time is as important as time itself. And even though it is correct that long-run returns are the returns that truly matter, the fact is that we live in the short-term. During years like 2022, it is very difficult to say: “not a problem, all will be well ten years from now…”
Data is another tool that should be used to help keep our perspective.
For example, in the context of 2022 many investors may forget that during the last four years, from 2019 through 2022, the S&P 500 returned 13.1% per year. If you had $1,000,000 invested in the S&P 500 in 2020 and did not make any withdrawals during this time, your money grew to $1,637,411 by the end of 2022.
Yes, on a pure return basis, stocks have done well from 2019 through 2022. They were up in 2019, 2020, and 2021, and down in 2022. But again, this is only so comforting after a year of portfolio declines.
A third tool advisors use is to highlight the biases to which all humans are subject. For example, “recency bias” is the tendency to give greater weight to recent events over more historic ones. In the context of today, this would mean assuming 2023 will be a bad year because 2022 was, ignoring the years of 2019 through 2021.
In reaction to all of these tools, a client could reasonably respond: “I understand the data that illustrates 13% average returns over the last four years, and I am well-aware of my own biases. Still, this year was hard, and there is a lot out there in the world that has me feeling uneasy about the future, which is what I really care about.”
To which we would respond: “You are absolutely correct.”
We think it is wise not to be overly optimistic, given the state of the world. There is no sense ignoring what we can all see:
- Uncertainty about the future rate of world-wide inflation
- Uncertainty about the fiscal health of the U.S. government
- Geopolitical uncertainty
Nor do we think there is no good news out there. On the positive side of the balance sheet, the effect of 2022 is that stocks and bonds are more attractively valued:
- Stocks are cheaper (although not cheap)
- Bond yields are higher
So it is prudent to expect positive returns in financial markets going forward. But it is also prudent to assume that these returns will be modest, with single-digit returns in stocks and bonds, and that these returns will come with more volatility. And while we all crave certainty, the fact is that we are stuck with uncertainty, now and forever.
For a more detailed and technical discussion of this past year, we encourage you to read our first Year-In-Review, included in this mailing, in which Professor Craig Mackinlay and Senior Investment Officer Dan Berkowitz discuss the investment themes of 2022, the actions we took, and our expectations for the future.