Do you understand the stock market? Maybe you know a little bit, or maybe you’re completely clueless. Either way, I’m confident you’ll learn something with this post. We’ll review some basics of the market and look into our strategy for managing investments at Bluestone. If you need a quick refresher on investing in general, check my last blog.
When people say, “the market,” they are likely referring to one of the below broad market indexes. Although they do not capture the entire market, they are a beneficial measuring stick for reference.
Dow Jones Industrial Average (“the Dow”):
- Tracks: 30 well established companies (Ex. Microsoft, Boeing, Honeywell, P&G)
- Indicates: Overall health and stability of the US economy.
S&P 500 Index:
- Tracks: 500 of the largest US companies. (Ex. Costco, Gap, J&J, Netflix, Nike, Tesla, Disney)
- Indicates: Strength of the equity market.
Investors will compare their portfolios (collection of investments) to these indexes to gauge success. In a perfect world, everyone would outperform the S&P or the DOW. Does that always happen? Not by a long shot. Mutual funds (type of investment vehicle) love to preach that their portfolios are professionally and actively managed, which they are, but it comes with a cost that ultimately decreases your return. In fact, over 80% of mutual fund managers underperform the S&P over five, ten and fifteen-year periods. Is that “professional, active management” still worth it? I’ll let you answer that.
Realistically, most people can manage their own investments, but few have the time at their disposal. This is job security for me. Clearly, the investment world is changing at a rapid pace. Apps (like Robinhood) have made it easier than ever before for users to trade. People are seeing the value of investing and everyone involved thinks they are an expert. Not to discount any success you might have had from listening to ‘Roaring Kitty’ on Reddit, or your investment in a cryptocurrency named after dogs, but let’s take a small step back.
Market success is largely dependent on the economy. An economy grows when the work force and its efficiency are consistently increasing. Currently, it is a great time to highlight how uncertain the economy can be. We are recovering from a global pandemic. We have a new president that has already proposed widespread tax increases. People are being handed stimulus checks and cryptocurrency (ex. Bitcoin) is gaining in popularity. These factors heighten the importance of diversifying your investments. So, how do you allocate a portfolio in today’s environment? Some financial planners would offer a “free consultation.” As exciting as that sounds, let’s dive into some of the principles that guide the way we manage money at Bluestone.
Managing a portfolio is difficult because it is impossible to know what will happen next. For example, COVID – did anyone have that pegged on their calendar? There are an exponential number of factors that can influence the market. Most people try to guess what will happen next based on different indicators, ratings, signals, blah, blah. No doubt, the resources are there. But how do you sift through and understand the data? How do you know what’s relevant? An argument could be made that there is too much information causing unnecessary noise and confusion.
We take a different approach and use data that is more predictable on a relative basis, including the business cycle, reversion to the mean and forward-looking effects. When planning with our clients, we’re not looking at the next 1-3 years. Instead, we’re looking at the next 5-10 years. Over time, we make changes based on where we see long term value and opportunity. These changes are not drastic because they are not supposed to be. Although a change may seem small, a slight shift in weight between asset classes can make a significant difference in success. For example, the difference between a 6.5% and a 7% return on a $500,000 portfolio over 20 years is a difference of $173,000. Drinks on you? Building wealth doesn’t necessarily come from the buying and selling. It comes from intelligent allocation and patience. Our strategy is not sexy, but money talks and it’s proven to be a more effective way to generate risk-adjusted returns over time.
Some investments this year have produced insane returns and I can only hope that some of you were able to cash in. But, is it sustainable? We’ll see. Sometimes you can get lucky, just like gambling. However, what happens when the luck runs out? I am in no way trying to deter you from managing your own portfolio, but rather see it from a different perspective. It’s not about having extra cash to spend now. Instead, look at the long-term picture and think about providing for your family. Plan for every scenario, including the worst case. It will never be easy, but should it be?
Gabe Martin is a registered representative of LPL Financial and investment advisory services offered through LPL Finanicial., a broker-dealer (member SIPC) and registered investment advisor. Insurance offered through LPL Financial affiliates and other fine companies.
The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and a widely recognized, unmanaged index of common stock prices. You cannot invest directly in an index.
The Dow Jones Industrial Average is an unmanaged index comprised of 30 top industrial companies and is considered representative of the general state of the stock market. It is not available for direct investment.
Asset Allocation is a strategy of how to invest among broad asset classes. The purpose of Asset Allocation is to control risk by reducing volatility or relative fluctuations in a portfolio thereby optimizing total return (investment returns, dividends and income). Asset allocation won’t guarantee a profit or ensure that you won’t have a loss, but may help reduce volatility in your portfolio. Diversification cannot eliminate the risk of an investment loss.