During the most recent quarter, U.S. Stocks (as represented by the S&P 500) have hit another all-time high. After a decade of above average stock returns and fears of the last recession a distant memory, it’s hard not to wonder if we should invest in anything other than stocks. After all, as you can see below, they’ve done phenomenally well over the last 10 years, especially compared to Cash and U.S. Bonds:
To put this into perspective, $1,000,000 in stocks would have grown to $3,096,220 while bonds and cash would have grown to $1,448,236 and $1,030,000, respectively. This is eye-popping wealth creation that causes even the most disciplined investor in us to consider throwing caution to the wind and going all-in with stocks. Of course, seasoned investors know there is no reward without risk. The reason investors are compensated with higher long-term returns in stocks vs. bonds and cash is because stock investors must endure significant declines in the value of their portfolios every so often. The orange line in the chart below represents drawdowns (% drop from the previous high to the low) in the S&P 500 since 1976.
As you can see, stocks occasionally go through very uncomfortable declines. For instance, in the Great Recession of ’08-’09, stocks fell by more than 50%. In dollar terms, $1,000,000 in stocks would have dropped to $490,500. For comparison, the blue line in the chart represents drawdowns for U.S. Bonds, which was barely a blip during the same period. Drawdowns in bonds have historically been a fraction of what they’ve been in stocks. This safety, however, comes at a cost: lower long-term returns.
Withstanding one of these stock market drawdowns is one of the hardest things to do in investing. In fact, there is often a capitulation point where some investors can’t handle seeing their portfolios go down any more and decide to sell. Selling during a stock market decline and going to cash is detrimental to one’s wealth. Not only is there the negative experience of a decline, but, more importantly, there’s no participation in the subsequent recovery. Therefore, we spend a lot of time with clients on what the “right” portfolio is for them. We want to avoid reaching a capitulation point.
The correct mix of stocks, bonds and other investments is unique to each person. For example, people who want to earn the highest possible long-term return, have a stomach of steel and a history of riding through downturns without selling, should probably have a portfolio of mostly stocks. [As an aside, just because someone can handle the downside of having all their money in stocks, doesn’t necessarily mean they should do so. If we can determine, through financial planning, all their financial goals are met with a lower return, why take the risk?] On the other side of the risk spectrum, people who would lose sleep if the value of their portfolio dropped anywhere near the amount of historical stock market drawdowns and are willing to accept a lower long-term return because of it, should own considerably less stocks. We serve both types of clients and everyone in between.
So, here we are, going on 10 years of great stock market returns. Is now the time to go all-in with stocks? The answer, of course, is it depends. Recent performance shouldn’t be the driver of what one’s portfolio should look like. The determining factor should be how one reacts when times get tough.
Within portfolios that have a mix of stocks and bonds, we do think there are certain economic environments when it makes sense to tilt more toward stocks and less toward bonds and cash or, conversely, less toward stocks and more toward bonds and cash. Given our economic indicators today, we are neutral on the stock market and are not tilted one way or the other. Of course, if our indicators change, we will change our tune.
If you have any questions or would like to speak with us, please don’t hesitate to reach out. If you know anyone who may be interested in this commentary, feel free to pass it along.
Michael Gallagher and the TPG Investment Committee.
Wealth Management / firstname.lastname@example.org / 800.434.4662
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