Sunday, September 15, 2019

Luck is No Substitute for Knowledge

Ask the CFP


“Confidence comes from discipline and training.”

~ Robert Kiyosaki, American Businessman and Author of “Rich Dad, Poor Dad” (1947 –  ).


Question: Even though the market has gained back most of what it lost at the end of 2018 I’m still concerned and uncomfortable with volatility. What tips can you provide to help prepare for the next inevitable downturn?

Submitted

Answer: Volatility is to be expected by investors. Having a disciplined approach and maintaining a long-term focus certainly helps, but some people still have concern and even anxiety when markets go down. Keeping the focus on real economic data and corporate fundamentals rather than paying attention to emotional pleas is easier said than done, but it’s exactly what’s required to steer through turbulence. Even when the data suggests that the economy is continuing to expand, it’s still uncomfortable for some investors to stay the course, I get it.

Evaluating your appetite for risk and designing an investment plan to match your needs and emotions is a great place to start. The relationship between risk and reward is real, we know that financial markets don’t go up in a straight line. As we know too well, in the short-term, markets are erratic. In my experience, unease is often the greatest for those who’ve recently retired and have begun taking withdrawals from their portfolio. Having a well thought out and designed plan that you understand may help guide investors through these times.

A basic understanding of economic fundamentals along with knowing the intended function of each investment in a portfolio may also help reduce any angst. Getting back to the basics of knowing what you own and why you own it may also decrease worries. It may sound elementary, but investors typically purchase shares of stock, which represent fractional ownership of companies, with hopes of increasing valuations. The relationship between the price of stock and the company’s earnings usually plays a part in the valuation of shares.

The average price-to-earnings ratio (P/E) since the 1870s has averaged 16.80 according to Advisors Perspective. There was an extreme disconnect in the ratio between share price and corporate earnings during 2009 when the overall P/E ratio jumped to triple digits during 2009. As a reminder, lower is generally better for price-to-earnings ratios. When stock prices are high and earnings are lower the resulting ration increases. Before the top of the Tech Bubble in 1999-2000, concentrated P/E ratios hit 34 and hitting 47 two year before the market topped out. Renowned Economist Benjamin Graham, known as the father of value investors and Warren Buffett’s mentor, observed the same bizarre behavior prior to the Roaring 20s. Mr. Graham and scholars of the day devised what is regarded as perhaps a more accurate way to calculate this measurement by averaging the number over a ten-year period of time to take into account business cycle shifts. A ten-year average cyclically adjusted price-to-earnings ratio (CAPE) may be a more useful and realistic measure as it smooths the cyclical abnormalities.

Having some familiarity with leading economic indicators (LEIs) may also be help weather Wall Street’s storms. LEIs quantify the health of an economy which is dependent on payroll numbers, sector trends, average hourly earnings, wage inflation, and jobless rates. Additional factors such as the Federal Budget, deficit levels, interest rates, inflation, trade negotiations, and geo-political events such as Brexit, also influence consumer sentiment, economic activity and therefore fundamental data when evaluating trends.  

It’s important to make an honest self-appraisal and evaluate why you’re involved with the financial markets. Are you investing or trading to own companies like Amazon that move double digits on a daily basis, or is it to provide a steady and consistent rate of return to meet your needs? The ability to adhere to a long-term plan and steer through all kinds of markets, including corrections, bear markets, and recessions can be incorporated into your plan. Ask your CFP® practitioner to model what a 10 or 20% decline would look like in dollars to see and feel how it may impact your plan.

Express any concerns with your advisor once the plan is in place. Keep your advisor informed as to any changes in your life that would impact your finances and your future. It’s helpful to have a suitable amount available for liquidity purposes. Knowing that funds are available may reduce fear based emotional reactions. This is why proper allocation is relevant when tailoring a plan to coincide with your comfort levels, no matter what the markets may be doing. Stay focused and plan accordingly.

All investments are subject to risk. The opinions expressed are those of the writer, but not necessarily those of Raymond James and Associates, and subject to change at any time. There is no assurance that any investment strategy will be successful. Asset allocation does not guarantee a profit nor protect against loss. The S&P 500 is an unmanaged index of 500 widely held stocks. It is not possible to invest directly in an index. Raymond James & Associates, its affiliates, officers, directors or branch offices may in the normal course of business have a position in any securities mentioned in this report. This is not intended as a solicitation or an offer to buy or sell a security referred to herein.

“Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.”  This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239-389-1041, email darcie.guerin@raymondjames.com. Website: www.raymondjames.com/Darcie.

Leave a Reply

Your email address will not be published. Required fields are marked *