Finance 101: Back to normal

Whatever that might be.

0

It’s almost the end of the year, and an eventful year it has been. Threats of trade wars, worries about a slowing economy, all the theater coming from Washington, D.C., and lots of other issues we didn’t seem to have just a year ago. Taking it all in now, the stock market has decided to act downright tetchy.

Were there things to concern us and the market a year ago? Of course there were. They just weren’t things that, in retrospect, the markets decided were worth getting tetchy about at that time. Things just stayed the same as they had over previous years, with markets steadily climbing higher. But things that stay the same can change all of a sudden. Which is actually normal in the grand scheme of things.

It’s also normal, for this time of year, to see hundreds of pundits’ predictions on what to expect for next year. Predictions are a useless exercise, and you would be well served by avoiding them altogether. Looking backward is actually more helpful in understanding what to expect in the future than trying to predict the immediate future. It provides us helpful context. So a general postmortem is in order.

At the beginning of the year, the stock market picked right where it left off in 2017, which was a hell of a good year with markets, here and abroad, going up well in excess of 20 percent. We hit a new all-time high in January, so things were looking up. At the time I wrote a piece called Bull markets,” and ruminated on how they can make us feel smarter and more willing to take risk. And how we are more likely to have more confidence than actual skill.

Beginning in February, the markets cracked sharply for the first time in a long time. Price movements became more pronounced, and people started entertaining their fears that were so long dormant. It’s a normal reaction. I started to worry too. I wrote a piece about the merits of worrying a little. The value in that worry is to motivate investors and savers to review their overall financial plan and how their money is invested. Worry should be motivational. And worry is normal. In fact, what we are seeing now at year-end is what normal actually looks like when it comes to the markets.

Since earlier this year the markets had recovered and moved to more new all-time highs in mid-September, we were now enjoying a 10 percent return after a scary start. Then the fourth quarter started, and with it a pretty unsettling December, where we are now eyeballing a loss of 3 percent for the year. That’s a 13 percent drop from its highs, which, coincidentally, is exactly what a normal stock market correction looks like. Literally down to the decimal point. So things are normal, even if they take some getting used to.

What we should consider now is to start getting used to this new normal, even if it’s really just the old normal. It’s normal to have bouts of erratic and violent market changes. It’s normal to have years where stocks lose money or simply return nothing. It’s even normal for stocks to have several years in a row where they prove disappointing. This doesn’t happen frequently, but it does happen.

Do you know what is also normal? For investments like U.S. stocks to underperform after an extended period of outperformance like we have seen for the past decade. A recent Vanguard research piece estimated that U.S. stocks will return between 2 and 6 percent over the next 10 years. And it is also normal for assets that have underperformed, like stocks outside the U.S., to then go on to outperform in the future. According to that same Vanguard research, foreign stocks will return between 4 and 9 percent.

The problem with any kind of prediction is that it may well be true, but we don’t know when it will actually happen. We could get the estimated returns Vanguard states, but we could go down a lot before we eventually recover and make positive returns. Picture a scenario where we lose money for five years, and only then make much more the next five. Or U.S. stocks still outperform foreign stocks for the next couple of years or more. Anything could happen in the short run. Which again is normal.

We can only look forward with a measure of confidence when we look at how many abnormal things are actually part of what is possible in a normal market. We can look to probabilities to best move forward. But knowing that the probabilities favor a certain approach doesn’t mean you will get what is probable. The Vanguard return estimates are based on a 75 percent probability. So 25 percent of the time, we won’t be getting that range of returns. You pays your money and you takes your chances. Odds of 75 percent are pretty good.

So what should you do now? Do what normal markets reward. Be broadly diversified in U.S. and foreign stocks. Make sure you have high-quality bonds to smooth your ride. Have an actual written financial plan that is professionally produced. It will help you to better understand what your chances of success will look like, and how you can take the right amount of risk to reach your goals. It’s actually pretty boring stuff. But boring can be effective. It’s totally normal.

 

John Kageleiry is a business writer and financial planner. Have a question for “Finance 101”? Email it to jkageleiry1@gmail.com.