Keeping a Cool Head While Others Are Losing It

It has been a tough year for investors as diversified stock portfolios have declined by almost 20% from their highs last year. Bonds have failed to offer the stability we’ve seen from them in prior downturns, as their price declines from rising interest rates have more than offset their higher interest payments.

In my experience, most people have difficulty coping with a year like this. When nothing seems to be “working,” we become impatient and start looking for alternatives—strategies or approaches that don’t make much sense long term but are doing better this year. At the very least, even in the absence of an urge to make a change, a challenging year like 2022 can lead to unnecessary anxiety and frustration.

What’s the best way to keep a cool head during demanding investment environments when everyone else seems to be losing theirs? Here’s my advice:

#1 — Remember Why You Invest

We often forget why we’re investing when things aren’t going well. So let’s start by reminding ourselves that we are investing to achieve our long-term goals. We haven’t invested money that we’ll need in the next year or two into stocks; that should be in a savings account.

Some of us are investing for retirement several years or even decades from now. If we’re in retirement, our investments need to provide us with ongoing income to support us for several decades. Most clients also have family members or charities/organizations to which they would like to leave an inheritance or a legacy once they’re no longer living.

Whatever your goals, they aren’t due next year or even the year after. So why stress out over short-term market movements when your goals are anything but short term?

#2 — This Is What Your Required Returns Look Like

Most investors believe, “as long as we’re earning our desired return, we are fine; but if we hit a rough patch, the return we’re shooting for is unlikely.” Not true.

Diversified, growth-oriented portfolios don’t go up in a straight line at their long-term rate of return. Look at the 1985-2022 results of the Dimensional Core Plus Wealth Index Models in the chart below. The all-stock, 100/0 allocation returned a whopping +11.2% per year, and $1 invested grew to $54, the 80/20 stock and bond allocation returned +10.6% per year, turning $1 into $43, and the 60/40 stock and bond allocation returned +9.7% annually, and $1 invested grew to $32. Good returns for sure, but there were a lot of setbacks along the way.

Every three years or so, we should expect to see a double-digit decline in our stock portfolios. 2022 marks the 11th decline of -10% or more for the Core Plus 100/0 Wealth Index Model since 1985, and the average of these declines was -22.7%. Setbacks of -20% or more aren’t the exception; they are the rule. The allocations that included bonds declined less in most periods (this one is an exception), but the ending wealth was dramatically less.

You could sidestep the volatility by investing in “risk-free” One-Month US Treasury Bills, but that also comes with a price. At the bottom of the chart, you see the growth of $1 in T-Bills—just $3. Their annual return was only +3% a year, and all of that was lost to taxes and inflation.

By playing it safe, you lost money. In investing it’s important to remember—no pain, no gain.  And “no gain” won’t cut it.

#3 — Different Isn’t Different

Every time we go through a difficult investing stretch, the causes are unique; this is what always makes the current event the scariest.

In 2001, no one had lived through a terrorist attack, as we saw on September 11th. In 2008, we faced a global financial crisis for the first time as companies that were lynchpins of our economy went bankrupt virtually overnight. The US technically defaulted on our debt for the first time in 2011, which was new. The tariff battle in 2018 brought about fears of The Great Depression and the disastrous New Deal. And, of course, the outbreak of Covid-19 in 2020 and the resulting economy-wide shutdown was a black swan. Even today, rising interest rates and high single-digit inflation are scenarios we haven’t seen in 40 years.

Take a minute and acknowledge the novelty of these prior periods of economic and investment difficulty. Today is different, yes. And that makes it no different than any of these earlier periods. What’s not different across each of these episodes is the response of a diversified portfolio. Stocks tend to fall temporarily, -15, -25%, and maybe once a generation -50%. But the declines are temporary, and the recoveries are surprising and swift. The worse the decline, the more robust the recovery tends to be.

Remember just a few years ago—after a collapse in stock prices caused the Dimensional Core Plus 100/0 Wealth Index Model lose about 26% in the first three months of 2020? It proceeded to go up over 68% over the next 12 months! In the first 12 months of the recovery after the 2002 decline, the Core Plus 100/0 Wealth Index Model gained +31%. It gained +69% in the first 12 months after the 2007-2009 bear market and +23% in the year after the 2011 drop.  All of these gains are well above the long-term rate of return during all periods.

The only investors who ultimately lost money during these periods were the ones who sold out before the recovery happened. Shifting to a portfolio with more bonds would have been costly as well. The worst time to reassess your portfolio allocation is during a short-term stretch where it’s not doing as well as you had hoped.

#4 — Accept Uncertainty

We cannot forecast the short-term direction of the economy, the market, interest rates, the Fed, your portfolio, or anything else finance-related. The sooner you understand and accept this, the sooner you can stop worrying about it and start focusing on the things you can control.

I realize this unpredictability sounds like a stretch when media outlets are filling our inboxes daily with intelligent-sounding forecasts, so let’s look at the evidence. Professional money managers who run “actively-managed” mutual funds go to work every day trying to pick the “right” individual stocks and/or bonds or the “right” time to be in and out of the market. If the pros were any good at this, we would see the majority of them consistently outperforming an index of all the stocks or the bonds they’re picking from or trying to time. But we don’t

Look back over the last two decades of the 2,813 stock mutual fund managers and 1,584 bond mutual fund managers. They all tried to outguess the market through active management—yet only 18% and 15% successfully outperformed their index (the “winners”). 82% and 85% of the pros did worse than their index! Selection and timing are the surest way to disappointing investment returns.

Trying to predict future stock price movements or the right time to be in/out of the market was so unsuccessful that it put most active managers out of business. Consider the chart below; of all the thousands of stock and bond fund managers in business 20 years ago, only 44% of the stock and 50% of bond managers still exist today (the “survivors”). The remaining 56% and 50% did so poorly that their funds were closed completely!

The next time you consider an investment change or kick yourself for not doing something different to avoid a decline, ask yourself a simple question. Why do you think you can do this consistently and effectively when the professionals who study this stuff daily can’t?

#5 — Focus on Your Real Risks

What if you had to work five years longer than you wanted to? What if you could only afford to spend 50% or 60% of what you need to retire comfortably? What if you had hoped to leave behind the full value of your retirement portfolio when you pass away, but instead, it winds up depleted? These are the real risks that you’re trying to avoid.

Failing to achieve the long-term goals important to you is what we’re focusing on and trying not to have happened. In my experience, the main ways that investors come up short are:

(a) having an inappropriate portfolio in relation to your goals (that’s too conservative and whose long-term returns aren’t sufficient or too concentrated and therefore too risky)

(b) making the wrong investment decisions at the wrong time

The first reason is intuitive; the second one requires further explanation.

In a recent article, I discussed the high costs of missing out on the best month, quarter, or six months of returns for your portfolio over the long run. Just one ill-timed move could cost you -1%, -2%, or -3% per year of your return over several decades. The challenge is that these surprise surges, where a large percentage of long-term gains come from, tend to show up immediately following significant declines when most people are considering or have already made a change. Hence, the likelihood of missing out is high. This “mistiming” cost is one you cannot afford to bear. Fortunately, you are in complete control—stay the course with your portfolio until your goals change.

In summary…

It’s easy to get caught up in your portfolio’s short-term results when we’re constantly bombarded with the financial media’s negative narrative and we can check our balances every day. But day-to-day events don’t have very much long-term impact on your portfolio.

Well-designed and sensibly-diversified portfolios of stocks and bonds have historically achieved attractive rates of return over time, even when we include their temporary declines. You don’t need to avoid the setbacks to have a successful investment experience; you need to avoid selling into them and missing the surprise but inevitable recovery.

When investing, having a clear understanding of the things you can control and the things you cannot help to lessen our frustration. Knowing we can’t forecast the future, or outguess the market, takes the burden off the hindsight bias that “we should have seen this coming and done something different.”

Finally, if you can keep your attention on what you’re trying to accomplish financially throughout your lifetime—and even over multiple generations—it’s easier to remember what your real risks are:

  • not having enough to retire when you wanted to
  • not having enough income in retirement to live a comfortable life
  • not being in a position to leave enough (or any) of an inheritance or charitable legacy

Holding a growth-oriented, well-diversified investment portfolio is an excellent solution to these potential issues. But staying disciplined and rebalancing it during difficult times, like today, is essential to ensure it works as intended.

If you’re second guessing your investment plan, or you simply realize that you need a plan and can’t afford to wait any longer to get it set up, schedule a few minutes with me to talk about your particular situation.


Details of Dimensional Core Plus Wealth Index Models are available upon request.

Past performance is not a guarantee of future results. Index and mutual fund performance includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and should not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.