There have been studies on what we call loss aversion – the feelings of loss having a greater emotional impact than corresponding gains and how these feelings get stronger as the stakes grow larger. I have seen investors navigate through these feelings during times when the markets are stormy. When we are riding the highs and lows of the stock market, decisions we make can have long lasting financial implications.
As an advisor one of the things that I worry about is when clients sell stocks for no other reason than them being down. This is an emotional reaction that can have negative financial ramifications. This logic applies not only to the stock shares of solid companies but also stock oriented mutual or exchange traded funds.
Thankfully, most people do not do this and stick to the plan. When creating a retirement income plan one of the things we consider is a downturn in the stock market. A concept we have talked about and shared videos about called the bucket plan includes splitting our portfolio into two segments a soon bucket that is responsible for providing income for up to the next 10 years as well as a later bucket that is more growth oriented. Soon buckets have a focus on more stable and conservative investments with little to no equity or stock exposure. Later buckets typically are growth oriented and have a stock focus. This concept is helpful through navigating retirement income and periods of stock market volatility. This helps us reduce the risk of selling stocks when they are down. As we are using more stable assets in the soon bucket to provide income.
For those who have a long investment timeframe, stock can be one of the best ways to grow wealth. As of July 1st, 2022, Bloomberg reports S&P 500 5 year returns at 11.51%. This is in line with historical averages of a 10% return on the stock market. Equities or stocks have a fantastic opportunity for long-term growth. However, they do not come without risk and one of the big risks of stocks is that they misbehave or exhibit volatility from time to time. That is why it is so important to plan for this volatility and have areas of the portfolio that are more stable and help us navigate income distributions through volatile markets. In this way through the more stable investments in your soon bucket we are planning to be able to manage volatility in the stock market when it arises.
While it is the exception not the rule, occasionally I will have conversations with folks who want to stop the bleeding when the market is down and move their account balances to cash or out of stocks. This is typically a temporary move until they feel better about the economy and the markets. I very rarely ever see this as financially beneficial. It is exceedingly difficult to time the market, catch the upswing, and rebound. That is too hard even for most professional money managers to accomplish. What I see more commonly is when our emotions tell us it is going to be okay folks move back to following the plan and back into the invested portfolio or back into stocks. This occurs after the market has started its recovery, thus locking in losses. I have seen the negative impact to portfolios, net worth, and total wealth of an individual when this path is followed.
Thankfully, these cases are rare. Most people stick with the plan. And seeing the plan work through volatile times gives encouragement and faith that while there are no guarantees it is likely to continue to work in the future. Faith comes from the history of those great companies that make up our stock and bond markets and our faith in ourselves, the people of our great country who are spirited and innovative.
You can also watch the brief bucket plan video by clicking here