Even if you get back to even and “earn” all of your losses from a previous dip in the market, investors should not be complacent with large losses in their retirement funds.
Buy-and-hold aficionados will argue that the strategy works, because even though the market falls, it eventually comes back. That philosophy is a fallacy since investors can easily lose half of their net worth, said Matthew Tuttle, CEO of Tuttle Tactical Management in Stamford, Conn.
Investors who had $1 million in the Nasdaq back in 2000 when it reached a high of 5,135 lost a large chunk of savings when it crashed in October 2002 at 1,108 during the dotcom bust. While the Nasdaq has reached the 5,000 level again, this means that all the investors who left their money in the tech-driven index are back to square one and only have $1 million.
“The problem is that you should have at least $2 million today,” Tuttle said. “The longer you take this strategy out, the more you could have had compared to what you actually have.”
It is nearly impossible for a portfolio to regain its severe losses and earn more in addition to the initial investment.
“You never can catch up to what your portfolio should have been,” Tuttle said. “The answer is to take a tactical approach that can get you most or all of the gains while avoiding most, if not all of the losses.”
To beat any large market downturns, investors should turn to tactically managed account strategies or tactical ETFs, he recommends.
Volatility Can Be Reduced
Managing your portfolio passively by holding onto the same mutual funds and bonds means investors are more likely to experience greater risk and volatility, said Mike Kane, CEO of CEO, Hedgeable, a New York robo advisor focusing on downside protection in a bear market. Even if investors miss out on the “upside” or when returns are high, they have also eliminated the “downside” or the risk of large losses, which has a greater effect on long-term portfolio growth.
“Since markets don’t go up every year, investors don't realize the devastating effect losses can have on a portfolio because the hole is sometimes impossible to dig out from,” he said.
Hedgeable’s software will change an investor’s allocations automatically so they can avoid additional jeopardy to their retirement funds.
“The market and our economy is resilient and will most likely go up over time, but the goal of investing is not to get back to even, it is to grow your money,” Kane said.
Since markets can not produce positive returns year after year, avoiding a buy and hold strategy can prepare a portfolio from additional losses.
“We are not trying to beat the market,” he said. “By our calculations, simply mitigating large market losses historically would have meant $1 million more in retirement for the average IRA investor.”
Consumers should focus on maintaining the appropriate asset allocation prior to a large drop in the market, said Michael Brady, president of Generosity Wealth Management Boulder, Colo.
“An absolute buy-and-hold strategy is simply not appropriate for most investors,” he said. “Moderation is the key. While I'm certainly not an advocate for rapid speculation, I do stress the importance of working with an advisor who will modify a portfolio periodically to avoid unnecessary risk while capitalizing on good opportunities.”
Buy-and-Hold Philosophy Is Not Dead
The buy-and-hold philosophy is not dead for investors who hold value stocks and are patient, said Sreeni Meka, a registered investment adviser with Lakeland Wealth Management in Lakeland, Tenn. and a portfolio manager on Covestor, the online investing company.
Consumers should reallocate tactically, which is an on-going process based on microeconomic factors such as changes in “interest rates, business cycles and anticipated price changes in any given sector,” he said. Since the Federal Reserve is expected to increase interest rates later this year, Meka recommends that investors should not hang onto utility stocks and REITS. In addition, with energy prices declining, “betting on coal and mining equipment equities will not result in good returns.”
Instead, turning to consumer staples can be the “best bet given the improvement in the employment situation and uptick in the wage growth combined with lower energy prices,” he said. The stocks which are major beneficiaries in this market are retailers, restaurants and auto part suppliers.
Investors who don’t want the hassle or anxiety of reallocating large portions of their portfolio are good candidates for the buy and hold strategy, said Joe Jennings, senior vice president of PNC Wealth Management in Baltimore. Making decisions on the long-term merits of an investment can be profitable and this philosophy dictates that markets “maybe irrational in the short run, but are rational in the long run.”
“These investors are not concerned about weekly, monthly or even yearly gyrations in their holdings or the overall market,” he said. “Buy and hold investors believe that these movements are impossible to predict consistently and prefer to focus on investment performance over longer holding periods, such as 10 or 20 years.”
Portfolios Are Not Being Overlooked by Investors
Contrary to popular belief, buy-and-hold investors do not ignore their portfolios. They do rebalance periodically to stay within their “long run investment objective parameters and will sell positions if their investment thesis changes substantially,” Jennings said.
The unforeseen consequence is that buy-and-hold investors tend to outperform those who trade actively because of the transaction costs, taxes and opportunity costs. Opportunity costs often hold the largest potential to reduce returns because they are the costs “associated with misjudging the direction of an investment and may occur from attempting to time short-term security or market movements,” he said.
After establishing a strategic asset allocation of stocks and bonds, investors only need to rebalance periodically to avoid large losses, said Bob Johnson, CEO of The American College of Financial Services in Bryn Mawr, Pa. Investing in index mutual funds or ETFs helps consumers minimize transactions costs and fees.
Accumulating wealth means investors must avoid falling prey to “fear and greed,” because many individual investors become “overly optimistic following gains in the stock market and become overly pessimistic following losses in the stock market,” he said.
The typical investor winds up with recency bias in believing that the recent past will continue “unabated into the future,” Johnson said. The vast majority of individual investors do just the opposite and they sell off stock positions when the market falls and buys more when the market rises.
A better strategy is to rebalance your retirement portfolios once a year by selling some of the asset class that has outperformed and buy more of the asset that has underperformed in the recent period to maintain the same asset allocation mix.
“This allows the individual to maintain a portfolio that is close to his or her target portfolio weights,” he said. “If you start out with 80% stocks and 20% bonds and stocks perform better during the year than bonds, you would sell some stocks and buy some bonds to maintain the same 80-20 mix.”
--Written by Ellen Chang for MainStreet