What should I do with my investments right now?

By: David M. Foster, CFP®, CAP®

I’ve had several conversations with clients lately about whether we should “do something” in response to the current market environment. The assumptions implicit in that question are that A) we are currently doing nothing, and B) there is something we could be doing to reduce risk in the short term without materially impacting long-term returns.

This is a totally reasonable question for someone to be asking. In fact, it’s a question I have asked myself many times over the years and will continue to ask for as long as I do this job. Believe me, if there is a way to reduce my clients’ downside risk without harming their upside potential, I want to know about it at least as badly as you do!

I have three responses to this question:

#1 - We are doing something

Not making any trades or switching any investments is not the same thing as “doing nothing.” We are actively deciding to stick to the investment plan that we established. Part of that plan involves not panic selling quality investments or changing strategies based on short-term market movements. That plan, when it was established, took into consideration not only the possibility that we would experience a market like this at some point, but the certainty that we would, probably several times over the course of the next few decades.

Remember, the goal of your investment plan isn’t to generate income this year or even for the next five years, it’s to generate income for the remainder of your life! The reality is that investments and strategies that will limit short-term volatility are also likely to limit long-term returns, which brings me to point #2…

#2 - You can’t take less risk, you can only trade one type of risk for another

When people say they want to take “less risk,” what they usually mean is that they want to limit volatility.

Limiting volatility is easy. Simply liquidate all of your stock and bond investments and deposit the proceeds into an FDIC insured savings account. There is no “safer” place to be if your objective is to hide from volatility.

But, let me be crystal clear, you are not taking less risk, you are just taking different risks!

By doing this, you would be exposing yourself completely to inflation risk and the corresponding risk that most retirees and aspiring retirees face, which is the risk that you won’t be able to live the lifestyle you want to live in retirement, which is kind of the whole point of saving and investing, right?

I'm not suggesting that it's never appropriate to trade one type of risk for another, just don't be fooled into thinking that, in doing so, you are taking less risk.

#3 - Deciding what not to invest in is just as important as deciding what to invest in

Deciding how to invest is actually quite simple once you’ve decided how not to invest. Unfortunately, deciding how not to invest is quite tricky. There is an endless buffet of investments and strategies one could select, and an endless parade of salespeople for the companies that create them who excel at using your emotions against you to convince you of all the reasons why you’d be an idiot not to invest in their fund/strategy.

I promise you, whatever investment or strategy is currently being pitched on CNBC or Money magazine is one I’ve heard of, researched, and actively decided not to invest/engage in at some point in the last 14 years.

An incomplete list of things I’ve decided not to invest mine or my clients’ money into:

• Actively managed mutual funds
• Individual stocks
• Options
• Closed end funds
• Gold
• Commodities
• High yield “junk” bonds
• Cryptocurrencies
• Non-traded real estate investment trusts

I have considered each of those investments as options for a portion of my client’s money, and, in each case, I’ve decided that owning those investments was more likely to reduce my client’s income in retirement than increase it, so I have rejected them.

I won’t bother listing the names of all the various investing strategies I’ve rejected over the years, because they all, essentially, fall into one category, which is “timing the market.”

In contrast to “buy and hold” investing, these strategies will change their allocation to various investments in response to changing market conditions. Sometimes, they’ll change their allocation based on objective signals like, for example, the cyclically adjusted price-to-earnings ratio (CAPE). Sometimes, they’ll change their allocation based on the gut feel of the manager of the strategy. Success in these strategies either relies upon the future looking exactly like the past (in the case of the former methodology) or on an individual or group’s ability to predict the future (in the case of the latter methodology).

When it comes to the future looking exactly like the past, I don’t think I have to tell you that, given all the unprecedented things that have happened in markets the past couple years, betting on that seems like a scary proposition.

As far as predicting the future, I know it seems obvious now that inflation was going to be out of control, therefore the Fed would have to raise rates dramatically, therefore stock and bond prices would fall, therefore we should’ve sold everything and gone to cash, right?

Well, first, let me introduce you to the concept of “hindsight bias.” 

Second, let me offer you this example:

In September of 2020, the median projection for Federal Reserve Board members and Federal Reserve Bank presidents was that it would take until 2023 for the unemployment rate to get down to 4%. Instead, we got there by December of 2021.

In June of 2021, that same group’s median forecast was that there would be no rate hikes until 2023. In other words, the Fed Funds rate would be set at 0%(ish) at least through the end of this year. Well, as of right now, that rate is 3.25%, and the year’s not over.*

Not only was this group not capable of predicting the how the broader economy would perform, they couldn’t even predict their own behavior! Of course, their predictions about their own behavior were mostly dependent on their predictions about the broader economy, but that’s kind of the point.

If this group of people, who are selected for their understanding of how the economy works and whose entire job is to predict the future and then set policy based on those predictions, was so far off on those predictions, why would we think that anybody has the ability to predict the future ?

Putting It All Together

After sifting through all the investments and strategies I deemed unworthy of investing/engaging in, what’s left is this: globally diversified, low cost, low turnover, highly liquid, rules-based strategies, held through good times and bad. In other words, exchange traded funds (ETFs) that track stock and bond market indices from all over the world at a lower cost and are only sold in response to a change in circumstances, not movement in the markets.

The beauty of this investment strategy is that it doesn’t require you to successfully and consistently predict the future, which is impossible. It also doesn’t rely on the future to perfectly replicate the past. It simply requires you to endure the present, which may be incredibly difficult, but at least it can be done.

I'm not suggesting that living through down markets is fun; I wish I could tell you when this one was going to be over. But changing your investment strategy isn't going to make the end come any faster. 

As one of my favorite bands of all time famously stated, "Don't change horses in the middle of a stream!"

Thanks for reading!

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*Source: A Wealth Of Common Sense

The information provided here is for general information only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. All indices are unmanaged and may not be invested into directly.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. Past performance is no guarantee of future results.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The S&P 500 is an unmanaged index which cannot be invested into directly.

ETFs trade like stocks, are subject to investment risk, fluctuate in market value, and may trade at prices above or below the ETF's net asset value (NAV). Upon redemption, the value of fund shares may be worth more or less than their original cost. ETFs carry additional risks such as not being diversified, possible trading halts, and index tracking errors.