With stock and bond volatility at multi-year highs, BSW would like to pan back and attempt to put the current market environment into perspective. By providing a framework through which to view the market moves, we hope to provide some reassurance and peace of mind that your financial plan is still squarely on track. This framework pertains to BSW clients, and everyone with savings that they need or want to grow for future use.
The framework BSW uses when viewing any market environment has four key components. We call it the Success Pyramid (sounds better than Success Tetrahedron). These components fit together at a high level to provide a means to prevent our pre-programmed human emotions from sabotaging the magic of compounding returns. They are as follows:
- Time in the market
- Realistic forward return expectations
One can hold this pyramid up in any market environment, look through any of its triangular sides and be reassured that BSW is looking through the same pyramid as you. Through this pyramid we attempt to provide as clear a view as possible into your financial future– an inherently cloudy, unknowable point down the road.
The first side of the pyramid, time in the market, is important because markets tend to revert to a sustainable mean return over longer periods. At any given point, and during shorter periods of time, the stock market can trade well above or below this mean. Given this dynamic, BSW generally sets aside known cash needs that are within a year of being required. We also try to ensure that your plan has a realistic “time in the market” component. In other words, short-term plans (<5 years) have little to no stock market exposure, whereas stocks make up a more significant portion of longer-term plans.
Historically, business cycles have been known to last approximately five years; meaning that every five years the growth cycle turns into a contraction – and stocks generally follow this big wave. Due to so much monetary and fiscal stimulus since the Great Financial Crisis, the U.S. has not had a sustained economic downturn for 13 years.
We believe the chart below by Capital Group does a good job illustrating the average stock decline in terms of magnitude and frequency since 1952. Importantly, even through all the ups and downs, the market (as defined by the S&P 500 here) has finished up in 51 of those 70 years, or 73% of the time!
Check #1 – Do I still have adequate time to wait out (and take advantage of) market downturns?
If the answer is YES – I have more than five years – you can confidently move to the next side of the pyramid knowing that your best friend in investing, time, is on your side. If NO, or things have changed in your life that necessitates needing your savings earlier, speak with your BSW advisor to synch up on time expectations.
The next side of our Success Pyramid is realistic forward return expectations. These return expectations can help form the foundation of how to think about markets and their gyrations. Over the past 5+ years, we have grounded clients (and built plans) based upon a stock market return of ~6%/year. (Suffice it to say we don’t pull this number out of a hat. It is quantitatively formulated in coordination with institutional partners and is updated annually).
As the next chart will illustrate, our benchmark stock market index, the MSCI All Country World Index (ACWI), has provided an average annualized return of ~9.50% over the past five years – even through all the ups and downs. Hopefully many of you reading this have been exposed to stocks for even longer than five years, and if so, all the better!
Good news. If your plan included a stock allocation, this part of the portfolio (depending on individual circumstances of course) is likely well ahead of the 6% planned return as of this post.
If we zoom out to 10 years and use the exact same trend line as above, it is easy to see that the market fluctuates around a mean. Also, note how low below that mean we got in 2020 and how high above it we reached in 2021!
By grounding on realistic return expectations and, importantly, designing and stress testing plans around those returns, you can feel confident that even with a market downturn such as the one we witnessed in 2020, those moves are “baked into” BSW’s return expectations.
Check #2 – Do I have realistic return expectations?
Do I understand that even when the market goes lower, that it is part of the plan? If YES, give yourself a high five and move onto the next side of the Pyramid. If NO, BSW can walk through some scenario analysis with you to show you how historically, given time, the stock market is a serial generator of returns – no matter where your entry point.
Let’s move to the next side of the Success Pyramid, diversification. This one is self-explanatory but worth revisiting. We diversify for two main reasons. We diversify to mitigate idiosyncratic risk and to mitigate the undue influence of any one asset class within our overall portfolio.
Idiosyncratic risk can also be thought of as a specific risk – either specific to a single company or maybe a single sector. We don’t want too much idiosyncratic risk within portfolios.
I can give you a personal example of this. Years ago, I bought a stock called Wirecard in my retirement account. At its peak, it was a €24B German financial processing company, well respected and part of the German equivalent of the Dow Jones Industrial Average. It was audited by top-tier accounting firms and had been around for decades. Then one day in 2020, news leaked that the firm was under investigation for fraud. My gains quickly turned into massive losses and shortly thereafter, the firm was found to be insolvent, and the stock went to $0. Luckily, I practiced diversification and kept this stock position at a reasonable size in my portfolio. While the loss stung, it didn’t derail my plan. No stock is immune from this type of idiosyncratic risk. No company is immune from competition, being replaced, or becoming irrelevant over time.
We also diversify across asset classes because they often don’t move in lockstep, often respond differently to varied economic conditions and therefore can smooth the ride of the overall portfolio. A good example is the simple magic of mixing bonds and stocks over time.
A key takeaway from the above chart is this: There has not been a rolling 5-year period since 1955 when a blended portfolio of stocks and bonds has had a negative return. This might be a good thing to remember when the talking heads on TV and internet click-bait sites start to dramatize stock market movements.
Check #3: My portfolio contains at least two different asset classes, and no position within my portfolio has undue influence that could negatively influence my plan.
If YES to both, you can move to side four with peace of mind. If NO to either, let’s discuss why and confirm that either changes are warranted or that you have other assets that support your current position.
The last side of the pyramid can be thought of both in terms of risk management and opportunity – rebalancing. Rebalancing is the systematic adjustment of the portfolio in response to market moves.
A financial plan’s engine is a carefully planned target allocation to different asset classes. This engine is designed with the desired returns and the risk needed to achieve these returns in mind. When the target gets too off kilter due to market moves, they need to be brought back to the target to maintain the targeted risk/return profile.
If you refer to the ACWI charts above, a good example would be when stocks sank in 2020 during the pandemic. During this time, BSW sold bonds to buy stocks at low prices. We also trimmed stocks when they got to elevated levels in 2021. Over time, these moves should add to returns and keep the portfolio risk level in check. Although we do not rebalance monthly, (we do so at least annually and more frequently as markets warrant) the table below illustrates the value-add of rebalancing over time.
In the above illustration, you can see that by never rebalancing, the 60% stock (risky) portion of the portfolio grows to over 73% at one point and sinks to 56% at its low point. By doing nothing, the portfolio volatility crept higher, resulting in a portfolio that may perform much differently than the original engine design. When BSW designs that financial engine, whether it is meant to purr like a race car, put-put like an old Vanagon or chug like a work truck when the market pedal is pushed, we don’t want the resulting acceleration or deceleration to be a surprise.
Check #4: My portfolio is being monitored and rebalanced regularly to keep the risk profile in check.
If BSW is managing your portfolio, the answer is a resounding YES. If you are uncertain or want to learn more about how we perform rebalancing, please reach out. It’s a story we never get tired of telling.
That’s the Success Pyramid! If you answered yes to all the above, we believe you can confidently move forward knowing that your financial future is still as you and BSW cooperatively envision it in any market environment.
At the end of the day, BSW acknowledges that there is plenty to be gloomy about right now in the markets. Between the war in Ukraine, ongoing COVID concerns, China lockdowns and the potential for slower growth going forward, it is tempting to want to “do something.” Know that behind-the-scenes, BSW is constantly doing something – weighing the current risk (remember: the coast is never all clear), focusing on the fundamentals of the economy (employment and corporate profit growth) and, of course, scouting for opportunities.
Along those lines, BSW has just finished getting client portfolios back to target through a global rebalancing. We have added to our exposure of U.S. value stocks, reduced our exposure to both foreign and emerging market stocks (for now) and have begun tax loss harvesting within fixed income. Making lemonade out of the lemons we have been dealt this year is part and parcel of how we are always looking to optimize portfolios.
Speaking of sweet drinks – lemonade and lawn chair season is upon us. Enjoy the spring weather and we’ll be in touch shortly with another update.
Director of Public Investments
This blog is created and authored by BSW Wealth Partners, Inc., a Public Benefit Corporation (“BSW”) and is published and provided for informational purposes only. The opinions expressed in the blog are our opinions and should not be regarded as a description of services provided by BSW or considered investment, legal or accounting advice. Certain information sited is from third-party sources and while we believe the information to be accurate and true to the best of our knowledge, we cannot guarantee its accuracy as there may be certain unknown omissions, errors or mistakes. Use of third-party information, including links, is in no way an endorsement by BSW. The views reflected in the blog are subject to change at any time without notice.
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