Focusing on Goals vs. Markets

I often get asked the question, “What to do you think about the market right now?” No person on the planet has any idea where various asset classes will trade in the near term (the longer term being far more predictable). For a well-constructed portfolio of individual stocks and ETFs in the context of a prudently thought out financial plan, at best it doesn’t matter, and at worst it is focusing on the very wrong thing.

As you assess how you are ‘doing’ in your investment program, you should be thinking largely relative to your goals, not the stock market (a US-centric index like the S&P 500 is often not the best benchmark anyway for a well balanced portfolio containing gold/commodities, bonds, some cash, foreign stocks, etc.). Here are two common scenarios to make the point:

Near-Term Financial Objective

When we save and invest money, it is for a purpose – retirement, a child’s college, to purchase a house, etc. Sometimes the ‘when’ is uncertain, however we often have a pretty good sense of the time horizon of our investing. One of the most important rules in investing is to align your asset class with your time horizon. You wouldn’t sprint the first 100 yards of a marathon, or take your sweet time to start a 40 yard dash. Similarly, if you need money for lunch tomorrow, keep it in cash; if the money is intended for retirement 10-20 years hence, have a portfolio largely made up of stocks. For in-between time horizons, a combination of various assets is appropriate – cash, bonds, hedged stocks, etc.

If you are going to buy a home in the next 1–3 years, you should set aside cash for this purchase (in a money market, CD or very short-term bonds – people underestimate the risk to principal for longer-term bond holdings if interest rates were to rise) regardless of stock market conditions. Your goal and time horizon are clear: have a certain amount of money to put down on a house in the relatively near term. As we have learned over history (my first memorable example being October 1987 when stocks dropped over 20% in one day), a bull market can quickly turn into a bear market (and back again – as we have also seen, e.g. post BREXIT when stocks rallied quickly from the sell-off). Being very focused and disciplined is key. The fact that stocks are rising should not cause you to want to put your down payment money at risk for a possible decline should stocks drop prior to your home purchase date. Set the money aside, and sleep well at night knowing you are focusing on your goals, not irrelevant short-term market movements.

Long-Term Financial Goal

Many people are investing for retirement. And by ‘investing for retirement’ I don’t mean saving for the day you retire, but for the 10–30 years or more once you hang up the gloves. You may be withdrawing 5% per year, for example, meaning that 90%+ of the capital has an actual time horizon of well beyond your retirement date. Money has to be as intelligently managed during the retirement years – to make it last – as during the time leading up to retirement.

A common investment retirement goal is to have assets generate income in excess of withdrawal needs (e.g. 5%). With the 10-year treasury yielding around 2.2%, dividend paying stocks are a great way to generate current income, but more importantly future income far in excess of typical bond yields. This is something I’ve written on extensively in the past with interest rates today hovering around historical lows. There are great companies out there that have a history of not only paying consistent healthy dividends, but raising them annually as well (even during the financial crisis of 2007–2009). Let’s say a basket of these stocks yields around 3% (nearly 50% higher than the 10-year treasury) and your retirement begins in a decade. Assume as well that the companies in the basket on average increase their dividends by 7% a year (some companies like BA, AAPL, etc. have been averaging double digit annual dividend increases given their strong balance sheets). There are several financial forces working in your favor (ultimately captured in the powerful concept of compounding): 1) Dividends are being reinvested. You will have earned and reinvested around 40 payments per company owned over that 10 year period. 2) You are buying more and more shares each 90 days as shares reinvested the prior quarter now buy even more shares. 3) Dividends are being increased annually for the underlying companies, meaning that even more dividends are paid on top of even more shares. Combine these variables and the effective yield (your income in 10 years divided by initial investment) in 10 years can easily be in the 8% - 15% range or more. Meaning: future dividends alone can easily cover your annual withdrawal objectives of 5% without ever tapping the principal. This would be very difficult to achieve with low-yielding bonds which are of course subject to principal loss should interest rates go up.

To make the point even finer in terms of focusing on moving towards your long-term financial objectives rather than on short-term market moves, suppose we finally do get a correction or bear market, with stock prices declining 20% or more in the near term. That simply means you will be buying even more shares with your dividends in the near term (assuming of course the basket of stocks you purchased continues to maintain or increase their dividends in aggregate) leading to even higher future income. So rather than worrying about ‘beating’ the market as your gauge of success, you should be thinking in terms of, ‘am I generating ever-increasing income through purchasing more and more shares of dividend paying companies?’. As stocks drop in the near term, ironically you are getting even closer to your goal of future income, not further away. When you begin retirement in 10 years and your stocks are now spinning off material amounts of cash to fulfill your daily expense needs, you will be glad you were disciplined and focused on moving towards your personal goals, not fixated on what ‘the market’ was doing which often causes people to take near-term action inconsistent with long-term goals.

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