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Passing the Stress Test

posted on

November 04, 2014

The headline jumped from the TV screen, “After Record Highs, the Fall is Here.” Being the good investment advisor that I am, I of course stopped to see what had triggered the latest round of market selling only to learn that it was a weather report! What if this had been a stock market report instead? Just how should we react upon hearing of volatile stock market moves? Think carefully now, because your answer likely will determine not only your portfolio returns but your very ability to enjoy your retirement years.

European banks underwent a Stress Test in October to determine the soundness of their financial system. Perhaps we as investors could look upon the Stock Market Pullback of September as a Stress Test of sorts to assess the soundness of our own personal financial system. After crossing 2,000 for the first time in history, the S&P500 Index reached a closing high of 2,011.36 on September 18, 2014. Less than one month later, we had dropped almost 7.50% to a closing value of 1,862.49. While the S&P500 represents Large US Stocks, the Russell 2000 Index represents Small US Stocks. During this same period of time, the Russell 2000 fell by 11% and many international indices fell that much or more. For perspective, a globally diversified stock portfolio with a value of $1,000,000 might have fallen by $100,000 during this one month period. A similarly valued portfolio with 50% Stock and 50% Bond might have dropped by $50,000 as the bond portion of the account remained stable. Again, as a stress test measurement, how would you or how did you handle the September market slide?

Far too many investors chose to react by selling their stock positions only to miss the subsequent rebound in world markets. Why do so many investors choose to react by selling at the first hint of market volatility? One reason is that we remember past market declines and fear future ones. The next reason may surprise you upon first reading. That reason? We are smart people. Being smart people, we read, we listen and we think about issues and then we assume action is not only required but now demanded to keep our financial house in order during the coming storm. Throughout my long investment career, I’ve learned the importance of moving away from market timing and being concerned with short term market movements. The focus should instead be upon whether or not the portfolio is still in line to meet the longer term real financial goals of providing income during retirement and passing along a legacy to our families and communities. Make no mistake, markets will correct and when they do, the only energy directed at portfolio decision-making should relate to rebalancing back to the allocation mix that has the highest probability of ultimately helping you accomplish your real longer term goals. 

So considering these thoughts, do you pass the Stress Test? How are you handling the return of market volatility? Is your portfolio positioned to accomplish your long term goals? My simple advice would be to focus on the end results, whatever they may personally be for you (retirement income, estate planning, etc.) and then work backwards to design your proper asset allocation mix. Whatever you do, don’t get caught up watching the weekly weather or market forecast to help you make important financial decisions.