Professional Financial

April, 2023

Regulators took control of Silicon Valley Bank as a run on the bank unfolded at internet speed last month. Two days later, regulators took control of a second lender, Signature Bank. They were the second and third largest bank failures in U.S. history. Alarming media headlines have caused many to anxiously eye their portfolios for exposure to banks, regional or national.

We are confident that government intervention will cover potential losses for depositors of any bank that fails — at least this time around. Still, rather than worry about the security of a portfolio planned by Professional Financial when yet another crisis is headlined (do the headlines ever stop?), keep in mind the investing principles derived from financial science that are the foundation of your investment management strategy. Next keep in mind how critical you are to the long-term success of your investing goals by being committed to your investment strategy.

The banking crisis likely will have little impact on your long-term planning outcome. Client portfolios are implemented based on expected returns within the boundaries of your risk preferences and time horizons. Typically, the biggest goals such as for retirement have long-term event horizons. Properly informed planning allows for the anticipated time frame of expected future cash needs for retirement income or some other purpose. By staying focused on your plan and our time-tested principles, you can avoid making potential market-timing mistakes unrelated to whatever crisis is going on.

1. Uncertainty Is Always Unavoidable

Remember that investing is inherently risky. Uncertainty is unavoidable. Consider unpredictable events of the past three years: a global lockdown, the Russian invasion of Ukraine, spiking inflation, and persistent recession fears. Each provided some reason for panic. Despite all of these occurring, for the three years ending February 28th of this year, the Russell 3000 Index (a broad market-capitalization-weighted index of public US companies) returned an annualized 11.79%, slightly outpacing its average annualized returns of 11.65% since inception in January 1979. Such surprising returns support accepting market ups and downs and sticking with your plan.

2. Market Timing Is Futile and Costly

Inevitably, when news is bleak and headlines declare disasters in many places, investors’ thoughts reflexively turn to some version of market timing. The notion of selling to avoid near-term pain of loss is highly seductive. But research and practice repeatedly show that timing efforts lead to missing larger longer-term gains. The negative impact of missing market turning points and selling just ahead of a turnaround can far outweigh the benefits of feeling safe. Temporary relief is replaced with long-term regret of lost opportunity.

3. “Diversification Is Your Buddy”

Nobel laureate Merton Miller famously remarked, “Diversification is your buddy.” Informed diversification is the closest thing you can have to a “free lunch” in investing. Thanks to financial innovations over the last century such as mutual funds, and later ETFs, investors like you can access broadly diversified, sophisticated strategies like those of Dimensional Fund Advisors at very low costs. While not all risks — including a systemic risk such as an economic recession — can be diversified away (see Principle 1 above), diversification is still an incredibly beneficial planning tool that mitigates most concerns about the fate of individual companies.

The concept of globally structured diversification will not make any headlines. Yet like so many financial innovations over the last century, highly sophisticated investing that not even the wealthiest once could have, is highly accessible and affordable today. How does informed diversification work?

Diversification reduces the potential pain caused by poor performance or failure of a single company, industry, or country.¹ As of February 28, Silicon Valley Bank (SIVB) represented just 0.04% of the Russell 3000 of U.S. major stocks, while all regional banks combined represented only 1.70%.² For those with globally diversified portfolios structured by Professional Financial, the portfolio impact of failure was minuscule: For instance, as of February 28, SIVB was just one of more than 9,000 companies in the MSCI All Country World IMI Index (MSCI ACWI IMI) and represented a mere 0.03% of the index. As of the same date, regional banks in total represented only 1.15% of the index, with the largest at 0.10%. Despite bank failures, global diversification within an informed investment strategy drives more reliable outcomes for those sticking with their planning.

Conclusion

A systematically structured portfolio strategy for your family — the accumulated wealth you must depend on for your lifestyle and lifetime — will help you weather periods of headlined uncertainty. Essential to an informed investment strategy, is a trusted advisor who can guide you in remaining disciplined and sticking with an informed plan through uncertain times while pundits predict gloom and doom.

Planning for what can happen is far more reliable for gaining positive outcomes than trying to predict what will happen. Those who gained the best long-term outcomes from their systematic structured investing, were those who stayed disciplined through uncertain market ups and downs, who learned to stop listening to all that media noise.

Notes

1. Consider that a study of single stock performance in the US from 1927 to 2020 illustrated that the survival of any given stock is far from guaranteed. The study found that on average for 20-year rolling periods, about 18% of US stocks went through a “bad” delisting. The authors note that delisting events can be “good” or “bad” depending on the experience for investors. For example, a stock delisting due to a merger would be a good delist, as the shareholders of that stock would be compensated during the acquisition. On the other hand, a firm that delists due to its deteriorating financial condition would be a bad delist since it is an adverse outcome for investors. Given these results, there is a good case to avoid concentrated exposure to a single company. Source: “Singled Out: Historical Performance of Individual Stocks” (Dimensional Fund Advisors, 2022).

2. Regional banks weight reflects the weight of the “Regional Banks” GICS Sub-Industry. GICS was developed by and is the exclusive property of MSCI and S&P Dow Jones Indices LLC, a division of S&P Global.

March, 2023

Most are aware of last week’s closure of California’s Silicon Valley Bank and Signature Bank. They are the second and third largest bank failures since 2001. Over 85% of the deposits, it is estimated, were very large institutional holdings and thus uninsured. A haircut of 10% to 15% of the uninsured accounts was likely, as well as a lock up of funds for months. Since 2001, 506 banks have failed in the U.S. The largest was Washington Mutual back during the 2008 panic.¹

Following those events, the U.S. Treasury Department, Federal Reserve, and FDIC stepped in with decisive action to support depositors during this critical time. Those steps provide an additional layer of protection for individuals and will help boost confidence in the banking system. Whether guaranteeing even uninsured deposits at Silicon Valley and Signature and offering generous loans to other banks with poor management practices is wise policy (or even legal), remains to be seen. Despite official denials, this is a de facto banking bailout now endorsed by many in government who promised after 2008 that such action would never happen again.

Your Relationship with Charles Schwab

The clients of Professional Financial have their investable assets custodied primarily with Charles Schwab. We have custodied with Schwab for over thirty years. For over 50 years, Charles Schwab has been a safe, secure, and strong financial institution with disciplined risk management practices. Because of your trust placed in us, know these very important points:

• Schwab does not have any direct business relationship with Silicon Valley Bank or Signature Bank, so they do not have exposure to any direct credit risk from either.
• Investments at Schwab are held in investors’ names at the Broker Dealer. Assets in your accounts are separate and not commingled with any assets at Schwab’s Bank.
• Schwab has a broad customer base across multiple lines of business, capital well in excess of regulatory requirements, a high-quality and relatively small loan book, and a conservative investment portfolio that is 80% comprised of securities backed by the U.S. Treasury and various government agencies.
• Collectively, more than 80% of client cash held at Schwab Bank is insured dollar-for-dollar by the FDIC. According to S&P Global Market Intelligence, that percentage is among the highest of the top 100 U.S. banks.

Schwab, in our opinion, is a safe port in this financial storm. It has record-setting business performance, a conservative balance sheet, and a strong liquidity position. Please see the recent release of their regularly-scheduled Monthly Activity Report for more information.

Your Relationship with Dimensional

Our client funds are invested primarily through Dimensional Fund Advisors based in Austin, TX with other locations around the world. Professional Financial is wholly independent of Dimensional. We deeply believe that Dimensional can deliver a reliable client investment experience through their accumulated expertise, judgement, and skill to pull the right levels at the right time. Our investment management process employs their mutual funds and ETFs rather than select individual securities.

Dimensional does not physically custody any underlying securities they manage on your behalf. Securities in their funds are held by custodial banks that are restricted and limited in their businesses to holding securities of mutual funds, ETFs and similar vehicles. They do no “banking” in the conventional sense that Silicon Valley Bank or Signature Bank did.

Dimensional is part of the mutual fund industry with rules and regulations specifically designed to benefit investors. Mutual funds are regulated by the Securities and Exchange Commission (SEC) under laws including the Securities Act of 1933, Securities Exchange Act of 1934, and the Investment Company Act of 1940. Since those laws were enacted, there has been no investor loss due to fraud or malfeasance.

Dimensional Performance

Barron’s recently named Dimensional Fund Advisors No. 1 in their “Best Fund Families of 2022” list. The rankings look at the one-year records of how each firm’s actively managed funds performed vs. peers, based on data from Refinitiv Lipper. Dimensional also ranked No. 7 on its 10-year list, the longest time horizon included.²

While past performance is no guarantee or assurance about future results, Barron’s noted that Dimensional “sidestepped the meltdown in mega cap growth names and companies with few, if any, profits.” Good long-term outcomes despite bad times are what you need as you near or during your retirement years when working longer or saving more is not an option.

Reviewing Exhibit 1 the “Dimensional vs. the Fund Industry” for the previous 20 calendar years, we see the history of fund survival and out-performance of the fund industry overall relative to that of Dimensional’s funds is dramatically different. The average U.S. domiciled fund survives only 11 years, presumably due to underperformance. The underperformance history of those dead funds are usually replaced by new funds in the family. Since almost all of Dimensional’s funds survive, the high outperformance numbers have more meaning. Even most of the Dimensional “underperformers” are off by only a few basis points.

Exhibit 1: Dimensional vs. the Fund Industry

US-domiciled equity & fixed income funds outperforming benchmark as of December 31, 2022

Source: Dimensional Fund Advisors. Performance data shown represents past performance and is no guarantee of future results. The sample includes funds at the beginning of each respective period ending December 31, 2022. Survivors are funds that had returns for every month in the sample period Outperformers (winner funds) are funds that survived the sample period and whose cumulative net return over the period exceeded that of their respective benchmark. Each fund is evaluated relative to its respective primary prospectus benchmark. Where the full series of primary prospectus benchmark returns is unavailable, funds are instead evaluated relative to their Morningstar category index.

1.US-domiciled, USO-denominated open-end and exchange-traded fund data is provided by Morningstar.

2.Dimensional fund data provided by the fund accountant. Dimensional funds or sub-advised funds whose access is or previously was limited to certain investors are excluded.

Planning Expectations

Don’t focus your investing on trying to predict what will happen. Plan with an informed approach for what can happen in a way that minimizes potential mistakes.

What can happen? We can have much better news than expected, and returns would be strongly positive; news can be worse than expected, and returns would be more negative than expected. Inflation can be higher or lower than expected and impact stock or bond markets differently.

Our expectation for investment management is that stocks have positive returns, that lower quality bonds will outperform higher quality bonds, and that inflation will be modest.

Since those things can happen, how can you wisely plan a strategy for the unpredictable?

On the equity side, you can diversify. Avoid subjecting your portfolio to only one country or one sector by diversifying across countries and sectors. Don’t concentrate in stock selections or make timing bets that may lead to missing unexpected positive returns. Value stocks strongly outperformed growth stocks in 2022, after a series of disappointing years, returns that most investors missed.

But what about when markets go down? Plan for what can happen through asset allocation. Have an appropriate split of stocks and bonds suitable for your time horizon and your preference for market risk that mitigates the downside outcomes of a bad year.

An informed plan is focused on your goals. Stay disciplined by tracking performance against your goals. If news is better than expected, you won’t miss those positive stock gains, and causing your portfolio results to be worse than what they could have been.

Conclusion

Sound planning anticipates both good times and bad times. Your portfolio strategy should be planned to allow for a range of possible outcomes. A personally planned investing strategy, professionally done, should mitigate the impact of a negative event or enhance the benefit of a positive event, within some historic range of outcomes.

Professional Financial plans for what can happen with systematically structured strategies that encompass a set of potential outcomes without making predictions. In this way, planning can make you more confident of realizing your family’s hopes and dreams and you can have more peace of mind even in troubled times regardless of what is happening.

NOTES

• ¹The Largest U.S. Bank Failures in Modern History (visualcapitalist.com)
• ²https://www.barrons.com/articles/best-fund-families-f24ce2a4?mod=Searchresults

February, 2023

Many extreme events happened in recent years: a global pandemic, rapid burst of inflation, war in Europe, earthquakes, hurricanes, and floods in many regions and, last but not least, highly volatile financial markets. Hyper-focused media attention on terrifying events makes many feel that these times are especially uncertain, making them afraid to invest or to stay invested — even if sensibly planned.

Pretend now it’s the end of 2019. Prophetically you are shown the big events that occurred through the end of last year. Unfortunately, your vision included nothing about financial markets. Then you’re asked to predict and put money on how the U.S. stock market would perform. Will the overall market be up 25%? Flat? Down 25%?

Exhibit 1: Bigger Performance Picture

Growth of $1 invested in S&P 500 market index of U.S. stocks
January 2020 – December 2022

Source: Dimensional Fund Advisors. S&P 500 Index annual returns from S&P Dow Jones Indices LLC. Past performance is no guarantee of future returns. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. Market decreased 19.6% from Jan. 1, 2020, to March 31, 2020.

Including 2022’s 19% decline, Exhibit 1 shows that the market was up almost 25% from 2020 through 2022. Since brokerage statements tend to show returns by a rolling twelve months, many are surprised. The longer-run context of returns — even for their own accounts — is ignored. Yet that information is crucial for planning long-term goals. It’s essential for deciding how much should be allocated to stocks rather than, say bonds.

Exhibit 2: Calendar-Year Distribution of U.S. Returns

Distribution S&P 500 index of U.S. stock market by yearly occurrence, 1926-2022

Source: Dimensional Fund Advisors. S&P 500 Index annual returns from S&P Dow Jones Indices LLC.

Exhibit 2 shows the distribution of annual stock returns over 97 years based on research-quality market data. It ranges from a year when the stock market lost almost 50% to two years when it gained more than 50%. The bulk of the returns are between –10% and +40%. Histograms give you a sense of return distributions, while not making an effort to forecast what the next year’s return will be. The best prediction of next year’s return would be a random draw from one of those 97 years.

Exhibit 3: Two Steps Up, One Step Down

Distribution S&P 500 index of U.S. stock market by yearly occurrence, 1926-2022

Source: Dimensional Fund Advisors. S&P 500 Index annual returns from S&P Dow Jones Indices LLC.

Rather than focus on 2022’s outcome in isolation, let’s include an outcome with the two years prior. In Exhibit 3, 2020 and 2021 returns were both positive. All considered, these three years comprise a full market cycle: two positive years and one negative. Looking back many decades, we also may see three positive and one negative. Markets broadly appear to move forward and backward in an equilibrium cycle that no one can consistently predict.¹

Given so much bad news, how do we explain a longer-term positive stock market outcome? It’s because companies constantly innovate to figure out profit opportunities. When bad things happen, they don’t sit around and complain, hoping for another government rescue. Businesses respond creatively: when pandemic and lockdowns hit, markets dropped 20%.² But a vaccine was invented and then quickly distributed. Businesses large and small adapted in a thousand ways to keep operating all during that time.

Exhibit 4: Recent Returns Align with Long-Term Market History

Distribution S&P 500 index of U.S. stock market by yearly occurrence, 1926-2022

Source: Dimensional Fund Advisors. CRSP data from Booth Business School, University of Chicago. One-month Treasury bill data by Morningstar.

Exhibit 4 compares returns from 2020-2022 and for 97-years of the S&P 500 index and US Treasury bills. In the 94-years of 1926–2019, the S&P 500 index compounded at 10.20% per year. Treasury bills, which are a kind of risk-free asset, compounded at 3.32%. The difference between 10.20 and 3.32 is 6.88 percentage points: that 7% represents the equity risk premium — the reward for bearing stock market risk.

In 2020-2022 shown in the middle row, the S&P 500 compounded at 7.66% and Treasury bills were 0.64%. The difference between those is 7.02 percentage points. Surprisingly, that result coincides closely with the 7% equity premium of 97 years of market history!

In other words, in terms of U.S. equity market returns, the last three years of history have been “normal.”

How can we explain “normal” returns when the media news machine keeps announcing one new crisis after another? Public financial markets are a gigantic information-processing machine. Whenever bad news negatively impacts business, prices drop. When good news arrives, prices rise. Each day stock prices adjust to induce people to invest. If the future outcome of every stock had negative expectations, no one would invest. Stocks constantly adjust their prices so their expected return is always positive. Capital is thereby allocated among companies into its highest and most productive use.

Conclusion

Contango in commodity trading is a situation when a futures price is higher than the currently traded spot price. A futures price will converge toward the expiration spot price. Stocks are not commodities and have no spot prices. Yet over a long time horizon, stock price equilibrium becomes a kind of “dance,” stepping forward and backward, as traders try to spot return opportunities from price changes, impacting the market as a whole. Market prices collectively dance moving ahead and then back over decades, constantly in search of an unknowable equilibrium.

Don’t lose sight of your long-term investment planning goals. Remember that uncertainty is what creates opportunity for investors. Stocks have higher expected returns than bond investments because they require bearing additional risk. Without uncertainty and its volatility, you wouldn’t get paid for bearing the risk of owning stocks.

What will happen over the next three years? I don’t know. The good news is, if you have planned well with an experienced CFP® professional, you don’t have to know. That’s because you’re likely not fixing your hopes for a secure future on making predictions.

NOTES

• ¹Publicly at least. If they could, they wouldn’t tell you. They would borrow as much as they could to invest and keep all the gains.
• ²S&P data from S&P Dow Jones Indices LLC. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Decrease of 19.6% was from Jan. 1, 2020, to March 31, 2020.

January, 2023

Think back to December 2019. The economy was in high growth mode. Unemployment, interest rates, and inflation were at historically low levels. But what happened next?

• A mysterious virus led to unprecedented governmental lockdowns worldwide, dropping U.S. S&P 500 stocks alone nearly 20% in value by the end of March 2020.¹
• Later in 2020 markets would rocket after scientists announced new vaccines and lockdowns were made less restrictive.
• FAANG stocks soared in 2020… before giving up a lot of gains last year.²
• Meme stocks shot way up in 2020… and then plunged in price last year.
• Bitcoin and other cryptocurrencies reached record highs… and then crashed.
• Inflation spiked to the highest levels most Americans ever experienced.³
• U.S. bond markets collapsed, with the worst real returns in over a century.
• U.S. stock markets during 2022 posted their worst returns since the 2008 crisis.⁴
• Russia invaded Ukraine, triggering geopolitical turmoil and a humanitarian crisis.

I don’t know anyone who predicted more than a couple items. It’s the script of a bad movie. But what if a prophet forecast all this, and you believed it was from God? What would you change in your portfolio?

Next question: What if your guardian angel suddenly appeared, seeing your consternation, and also told you that, despite all that was coming, U.S. stock market would broadly return an average of 10% a year over those three years?⁵ Would you then have stayed systematically invested in the same diversified, allocated strategy from Professional Financial or similar advisory firms?

A yearly U.S. equity return of 10% is what happened! That’s very close to the stock market’s historical average over the past century.⁶ Those who maintained their investment planning strategy were rewarded.

A Balanced Look at 60/40 Strategies

Among the numerous memorable events in 2022 was the severe simultaneous decline of both fixed income and equity securities. The classic model 60% stock/40% bond balanced portfolio provided little to support the other asset category, leading some commentors to question the wisdom of this accepted institutional approach.

Although 2022 was the worst year on record for many bond indices, the performance of the 60/40 portfolio didn’t reach the top five peak-to-trough drawdowns that we see in close to a century’s worth of data.⁷ The drawdown that touched nearly 20% at its nadir was painful, but it’s only two-thirds of the 30% peak-to-trough drawdown investors endured through the recent but painful 2007–2009 period of the Global Financial Crisis.⁸

60/40 model portfolios recovered modestly late in the year, but still ended down about 14%. But in volatile times, you must focus not on where returns have been but rather on where they are expected to go. Recoveries of 60/40 model portfolios following a decline of 10% or more on average historically have shown strong performance in the subsequent one-, three-, and five-year periods (see Exhibit 1). Even more encouraging is that U.S. markets historically tend to perform unusually well the year following a mid-term election.⁹

Exhibit 1: A Case for Optimism

Performance of a 60/40 Balanced Portfolio following a market decline of 10% or more, January 1926 – December 2022

Past performance is not a guarantee of future results. Portfolio is 60% U.S. S&P 500 stock index/40% 5-Year U.S. Treasury notes. Drawdowns include all periods where the 60/40 portfolio declined by 10% or more from the prior peak. Peaks are defined as months where the 60/40 portfolio’s cumulative return exceeds all prior monthly observations. Returns are calculated for the one-, three-, and five-year look-ahead periods beginning the month after the 10% decline threshold is exceeded. The bar chart shows the average cumulative returns for the one-, three-, and five-year periods post-decline. There are 10, nine, and nine observations for the one-, three-, and five-year look-ahead periods, respectively. Source: Morningstar Direct as of December 31, 2022. Five-year US Treasury notes data provided by Morningstar. S&P data provided by S&P Dow Jones Indices LLC. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

Sticking with a Sound Plan

We can’t confidently predict where financial markets may be heading. Imagining a recovery when prices are falling, or when the media keeps talking about recession or when U. S. government debt reaches fantastic heights, is not easy. But evidence from a long historical view provides a basis to persevere even if a recession is ahead.

Recessions are always identified officially with a lag. The National Bureau of Economic Research (NBER) identifies phases of the business cycle using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures has been consistently dominant in the determination of economic conditions, and certainly past U.S. recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (due to the necessary economic data that is only available with a lag).

We know that the two years following a business recession’s onset, equities have a track record of mostly positive performance. This is due to the forward-looking nature of well-functioning and regulated markets, highlighting how stock prices reflect market participants’ collective expectations as they continuously re-predict the future profitability of companies looking forward, not backward like most investors see things.

An evidence-based perspective makes a strong case for periodically rebalancing back to equity policy targets even in a recession. Few who sold stock positions to increase cash holding in times of trouble, such as the early 2000s dot-com crash, also had the courage to timely re-position back into equities and so benefit from the market recovery. Similarly, those who quit their plan and sold stocks due to media hysteria of the 2008–09 financial crisis, or in March of 2020 as sensational COVID fears spread. Few benefited from the subsequent market rallies, and maybe even incurred losses. Those staying invested recovered each time and very often gained more than they ever expected to see.

When prices of growth stocks are well off their record market highs, maintaining an informed and balanced portfolio is essential for achieving hoped for long-term outcomes. Surprising rebounds after fearful steep market declines allow disciplined investors who had the courage to rebalance, to capture far greater market returns than they might otherwise expect.

Markets Work

What do I mean by “markets work”? When news of the 2020 pandemic hit, markets quickly adjusted, reflected by declining stock prices. When uncertainty about the situation peaked in late March 2020, investors in effect were demanding a very high return in order to invest or to stay invested. Suddenly, news of a vaccine appeared and lockdowns could be expected to end and business to resume. Market expectations adjusted accordingly — prices rocketed. Short term swings can be wild. Those prone to making emotional changes in volatile times and quit their investing policy, are risking their wealth as well as their health and maybe their marriages.

In economic language, the firm’s cost of capital is your return. As prices decline, your expected return as a well-diversified equity investor goes up, not down. A smart investor should sensibly have a strategy to systematically buy, not to sell depressed equities in time of severe market distress.

It’s unrealistic to believe that anyone can reliably predict the future (and share it with you, of all people) or that you alone in the world can outguess market movements years or even months ahead. Having faith in an optimistic philosophy and a systematic investing approach backed by decades of trusted academic-level research is not only better than speculating, but also much more likely to work successfully.

Publicly traded markets can be trusted to do a good job capturing the collective human ingenuity across thousands of exchange-traded companies. The current price of a stock may be considered a “fair” estimate of it’s value. After all, no rational person would buy a stock expecting to lose money. Prices constantly reset in the market so that the expected return of a security is always positive. (That doesn’t mean, of course, the price is always right, and won’t decline more.)

Stress-Testing in Real Time

The past three years have been a stress test of whether you could stick with your financial plan. Your plan could have been formal if working with an advisor or informal. Still, take a moment to think about how well you managed. The next three years could be more uncertain, and markets could be wilder.

First, we recommend that you make sure that your investment plan is truly informed, and then that the plan’s implementation be based on financial science. Second, make sure the plan is designed for your own unique planning horizon and risk capacity. Even the greatest plan in theory is no good if you can’t stay disciplined or are unexpectedly forced to sell stocks when depressed due to losing your job, as an example.

Investors who spend too much time actively trading, research shows, are not just potentially missing out on expected returns — they’re usually stressed out, always worried about the latest news alert, and forced to decide whether they should take action now and then try to find time to do it. They eventually get worn out, and the excitement of trading eventually fades.

Conclusion

We have an approach that let’s you relax, and not worry — and focus on what really matters.

Financial planning and wealth management look at your complete wealth picture. A team of CFP® professionals bring together the different parts of your financial life to build a lifetime roadmap. We help you maximize your potential for meeting your deepest financial goals and dreams. We help families develop a sensible plan unique to their situation, that can give them confidence about their financial future even as the latest news of yet another market crisis terrifies others.

So, for those who are clients of our firm, remember how much your planning strategy with Professional Financial has helped you accomplish over the past three, five, ten, twenty and maybe more, years. As you examine your annual report, consider how far you have come with wealth planning that has reliably captured the benefits of capitalism around the world through financial markets over the years. We hope you can confidently continue to look forward to realizing a lifetime of goals and dreams.

NOTES

• ¹ S&P data © 2022 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Decrease of 19.6% was from Jan. 1, 2020–March 31, 2020.
• ² Facebook-parent Meta, Amazon, Apple, Netflix, and Google-parent Alphabet.
• ³ Gwynn Guilford, “U.S. Inflation Hit 7% in December, Fastest Pace Since 1982,” Wall Street Journal, January 12, 2022.
• ⁴ Akane Otani, “Stocks Log Worst Year Since 2008,” Wall Street Journal (December 31, 2022), A1.
• ⁵ U. S. Russell 3000 Index annual returns December 2019–November 2022.
• ⁶ U. S. S&P 500 Index annual returns 1926–2021. S&P Dow Jones Indices LLC, a division of S&P Global. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
• ⁷ The 60/40 portfolio consists of the S&P 500 Index (60%) and five-year US Treasury notes (40%). Five-year US Treasury notes data provided by Morningstar. S&P Dow Jones Indices LLC, a division of S&P Global.
• ⁸ Peak-to-trough drawdowns include all periods where the 60/40 portfolio declined by 10% or more from the prior peak. Peaks are defined as months where the 60/40 portfolio’s cumulative return exceeds all prior monthly observations. Troughs are defined as the months where the 60/40 portfolio’s cumulative return losses from the prior peak are the largest.
• ⁹ Paul Byron Hill, “Pre- and Post-Election Investing Considerations” (October 2022). Accessed at https://www.professionalfinancial.com/pfs/pre-and-post-election-investing-considerations/

December, 2022

Negative stock returns and aggressive U.S. Federal Reserve interest rate hikes have many concerned that another Big Recession is coming — if we’re not already there. Media commenting on the possibility creates even more worry about markets sinking further among investors. Investors often delay taking actions to sell only when a recession is officially announced.

History shows, however, that markets incorporate recession expectations months ahead of economic reports. By the time one is called, the worst of the market declines has usually already occurred.

• The global financial crisis offers a lesson in the forward-looking nature of the stock market. The U.S. recession spanned from December 2007 to May 2009, as indicated by the shaded area in the chart.
• But the official “in recession” announcement only came in December 2008 — a year after recession had started. By then, stock prices had already dropped more than 40%, reflecting collective participant expectations of how the slowing economy would affect company profits.
• Although the recession ended in May 2009, the “end of recession” announcement came 16 months later (September 2010). US stocks had started rebounding well before the recession was over and continued to climb after the official announcement.

Exhibit 1: US Recession and Stock Performance During The Global Financial Crisis

S&P 500 Index, January 2007–December 2010

Decline based on the S&P 500 Index’s price difference between the actual start of the recession in December 2007 and the official National Bureau of Economic Research “in recession” announcement 12 months later. Announcement for the end of recession was 16 months after the actual ending.

Recessions are always identified officially with a lag. The National Bureau of Economic Research (NBER) identifies phases of the business cycle using a bevy of indicators, such as consumption and income data, employment rates, and gross domestic product growth. None of these measures has been consistently dominant in the determination of economic conditions, and certainly past U.S. recessions have come in all shapes and sizes. Recessions are therefore named retroactively, with the benefit of hindsight (and the additional economic data that is available with a lag).

Exhibit 2: Official NBER recession announcements vs. US stock market lows

Start and end dates of US recessions, along with announcement dates, are from the National Bureau of Economic Research (NBER): Business Cycle Dating Committee Announcements and US Business Cycle Expansions and Contractions.

Financial markets are constantly processing new information, pricing in expectations for companies and the economy. Because recessions are invariably proclaimed after a delay, rather than in real time, markets are often well on the way toward a recovery by the time an official announcement is made. As shown in Exhibit 2, the stock market had already bottomed out prior to the announcement month in two-thirds of recessions since 1980. In 2020’s recession, for example, the market’s low point came in March, three months before the announcement in June 2020.

Conclusion

The takeaway for planning investment strategy? Looking beyond the hype of media headlines, and sticking to an informed planning approach based on research from financial science, better position you for successful outcomes. When a recession is officially declared, we believe the most sensible approach is to ignore it and remain disciplined when holding a well-diversified asset allocation within your risk tolerance and capacity. Reducing exposure to stocks after an announcement is made is more likely to lead to missing out on a recovery that may have already begun.

Don’t let market swings or media messages drive impulsive choices. Have realistic expectations about the range of likely outcomes based on a thoughtful investment policy. And have a trusted CFP® professional help when you cannot trust yourself.

November, 2022

Bonds have done so poorly this year that many investors wonder about still holding bonds. Others see a great opportunity in fixed income securities due to greatly increased yields. U.S. government bonds now yield over 4 percent; other developed countries exceed that. Non-government bonds yield even more.

While those who held bonds for portfolio stability have been disappointed, losing around 16% this year — yet yields are now available that haven’t been seen in over a decade. A painful drop of 21% in U.S. stocks is causing former bond investors who never liked stocks but needed more return, and so bought growth stocks as an alternative, to rethink their strategy.

Yet many are hesitant to take advantage of higher yields, fearing that more interest rate increases would negatively impact the value of their new bonds and bond funds even more. Bonds are subject to loss of principal when interest rates rise.¹ That would be a mistake. Even if stock markets reach a cyclical low and go up, bondholders who maintain their positions can still enjoy a reasonable stream of return regardless whether yields rise.

Here is a smart way to think based on market prices: even if yields rise, investors planning for higher expected returns can be better off with investment grade bond positions as long as they maintain a consistent duration for their fixed income strategy that corresponds to their planning horizon.

Recovery Race

Rising yields impact fixed income portfolios in multiple ways. On the one hand, bond portfolios with longer durations (the weighted average of the maturity of the bonds adjusted for reinvested cash flows) could experience more losses as interest rates continue to rise. On the other hand, new higher yields for investment-grade bonds ordinarily lead to higher expected returns.

This tradeoff is like a pit stop in a Formula 1 auto race. A pit stop causes the driver to fall back in time relative to competitors. However, fresh tires may help that driver to outperform and still win if enough laps are left to catch and pass the leader.

Exhibit 1: Recovery Race

Growth of a $100,000 fixed income allocation with a five-year duration

For illustrative purposes only. Fixed income securities are subject to increased loss of principal during periods of rising yields. Data presented are based on mathematical principles, are not representative of indices, actual investments, or actual strategies managed by Professional Financial, and do not reflect costs and fees associated with an actual investment. Growth of wealth assumes a constant duration and flat yield curve for simplicity. For Scenario 2, the approximate 15% drop in value shown in year 0 is based on a hypothetical yield increase from 1% to 4%, causing an immediate decline in value. The drop in value can be approximated by multiplying the assumed five-year duration by the yield increase.

Exhibit 1 illustrates this point with two $100,000 fixed income allocation scenarios, both with a five-year duration. Scenario 1 experiences only a constant yield of 1%. Scenario 2 suffers a sudden spike in yields from 1% to 4% on Day 1 and has an immediate drop in principle value to a little over $86,000, much like occurred this past year.

However, Scenario 2 now benefits from a higher yield that not only accelerates recovery but allows long-term outperformance: with a 4% yield rather than the previous rate of 1%, Scenario 2’s portfolio value overtakes Scenario 1’s within five years — a time horizon determined by the duration of Scenario 2’s bond portfolio.

Duration measures the sensitivity of a fixed income investment’s price to changes in interest rates. Generally, longer-duration bonds will have greater sensitivity to changing interest rates than lower-duration bonds. A five-year duration is what many clients of our firm have and this implies a reasonable expectation for them.

Conclusion

When faced with uncertainty, investors should focus on what is controllable. Research tells us that trying to outguess the market by just holding cash, waiting for the possibility of future yields to increase may not achieve long-term goals.² Markets incorporate new information about interest rates and inflation before you can act on it profitably.³

Informed investors with a long-term horizon maintaining appropriate planning strategies, even with higher interest rates in the future, should still expect a successful investment experience and not worry.

NOTES

¹ The Bloomberg Global Aggregate Bond Index (hedged to USD) returned –12.1% from January 1, 2022, through September 30, 2022.

² Doug Longo, “Bonds Deliver Positive Returns in July 2022,” Insights (blog), Dimensional Fund Advisors, August 12, 2022.

³ Wes Crill, “Light at the End of the Inflation Tunnel,” Insights (blog), Dimensional Fund Advisors, June 10, 2022; “Markets Appeared to Be Ahead of the Fed,” Insights (blog), Dimensional, June 16, 2022.

October, 2022

KEY POINTS

• It’s difficult to identify any election year systematic market return patterns.
• Market returns on average have been positive the year following mid-term elections.
• Market expectations associated with elections are embedded in current prices.

It’s almost Election Day in the U.S. As we know, every two years the full U.S. House of Representatives and one-third of the Senate are up for reelection. While election outcomes are uncertain, we can be certain to expect plenty of opinions and prognostications in the media.

In the financial media, any topic perceived having an impact on the market and stock prices will be covered ad nauseum. The Wall Street Journal recently published, “After Punishing Year for Stocks, Investors Aren’t Betting on Post-Midterm Rally” speculating whether an 80-year record won’t happen again in 2022 — the worst year for U.S. stocks since 2002 during the tech bust.¹ But whether who wins or loses their election campaigns, or which political party gains control, should that really matter for an informed investor with disciplined planning strategies and practices?

Markets Work

Investors instinctively want to make reactive changes from fear or greed due to various media opinions, attempting to either avoid losses or make bigger gains from potential changes in policy. But modern financial markets, processing millions of trades daily, are highly efficient information-processing machines expressed through current share prices of each company on the exchanges.

Buyers and sellers both have some information they use for trading. The aggregate of all trades using that collective information with money at risk sets “fair” prices. Outguessing security prices and price movements is very difficult.² Evidence shows that the market’s pricing power, after costs, works against even the most skilled professionals with the best resources that money can buy.³

The 2016 presidential election is a prime anecdote. Many columnists and pundits at the time predicted market disaster, speculating that stocks and the sky would fall if terrible Trump were elected president.⁴ The day following Trump’s surprise win, however, the S&P 500 Index closed 1.1% higher and continued higher not only through that year, but into and through the next year.

But even if that popular narrative occurred, an investor who had correctly predicted the election outcome may not have also predicted the market’s directional move upward. Surprises are, by definition, unpredictable — so that either way things turn out, investing outcomes don’t necessarily turn out in a consistently clear-cut way that increases the value of your portfolio.

Should non-Presidential midterm congressional elections be any different? For this November’s elections, market strategists and news media once again will present highly convincing arguments not only about who will win but also the consequential market impact. However, data for the stock market going back to 1926 shows that extreme returns, negative or positive, rarely occur.

The party gaining control hasn’t been a reliable driver of direction or magnitude of market movements from the election month data. Returns in election months don’t differ much from non-election months. All that political sound and fury, signifies not all that much for investing.

Exhibit 1 shows S&P 500 Index returns by month back to January 1926. Each horizontal dash represents one month, by increasing market returns in 1% increments from left to right.⁵ Blue and red horizontal lines represent those months with a midterm election. Red is for when Republicans won or maintained Congressional majorities in both chambers, and blue is the same for Democrats. Striped boxes indicate mixed house control. We see that regardless of which party controls, that election month returns varied within a normal return range.

Exhibit 1: Histogram of S&P 500 Index Returns and Mid-Term Election Months by Party

January 1926–June 2022, Monthly Returns

Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.

Disciplined Investing Ignores Elections

The media’s business goal is to distract you with daily, monthly and annual market information to briefly capture your attention long enough to read the ads they sell. What matters most to you as an investor is how your wealth grows over your lifetime and does so most reliably so you don’t die broke. Exhibit 2 illustrates the hypothetical growth of wealth of $1 in an S&P 500 Index equivalent beginning January 1926. It also shows which party by year has Congressional control. Time and again, periods of significant growth and significant decline occurred during the majorities of both parties. No party pattern is apparent. Markets provide returns irrespective of the party in power.

Exhibit 2: Growth of U.S. Stock Market and Congressional Party Control

Growth of $1 for S&P 500 Index hypothetical returns, July 1926 – June 2021

Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Diversification does not eliminate the risk of market loss. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit.

Nearly a century of U.S. stock market returns suggests that investing based on which political party will control or may control Congress does not improve your investing outcomes. Congressional politics is only one factor of hundreds that set prices as they trade on the markets.

Businesses continue to operate for profit, providing goods and services for people to buy regardless of, and often despite of, a sometimes-hostile political environment. Not only Congress, but dictates by Presidents, state legislatures, government bureaucracies, regulatory agencies, and foreign governments will impact the future profitability of businesses and hence the price of their shares. But so will interest rate changes, technological advances, climate disasters, geopolitical events, and hundreds of factors and future events impossible to know or even imagine, like Covid lockdowns.

Realistic Planning for Returns

Portfolio returns that you realize depend not only on your approach (such as indexing the broad U.S. stock market), but whether you remain invested, and the ongoing consistency of your strategy over time. Economic theory tells us your expected return is always positive, even if a realized return has not been positive for months and occasionally years. (In that case, keep extending your evaluation period to correspond with a sensible investment policy of at least 5 or 10 years).

In 15 of the last 24 U. S. mid-term elections, we see in Exhibit 3 that returns were positive. 9 years were negative. The average return was 8.6%, and the average 4th quarter return was 6.5%. But only those who were invested and stayed invested, benefited. This year, if only 6.5% occurs, your year’s return likely will be negative. But a bad outcome does not mean that your planning was bad. Negative years periodically due to market volatility are part of a normal investing experience.

Exhibit 3: Market Returns Mid-Term Election Years

S&P 500 Index of U.S. Large Stocks: 1926-2021

Exhibit 4: Market Return, Year Following Mid-Term Elections

S&P 500 Index of U.S. Large Stocks: 1926-2021

Source: Dimensional Fund Advisors. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. Source: © S&P Dow Jones Indices LLC, a division of S&P Global.

For those whose planning horizon extends beyond a particular quarter, Exhibit 4 shows that in 22 of the last 24 years that followed Congressional mid-term elections, outcomes were positive, averaging 18.5%. That could offset 2022’s declines for many investors. Regardless of the averages, stocks investing tend to reward those who are disciplined no matter who controls the U.S. House or Senate, especially when you add in all those positive years that follow U.S. Presidential year elections — plus all those many years when there are no Federal elections going on at all.

Conclusion

Equity markets offer an excellent way to grow your wealth and have a financially secure future. But intense competition among participants creates short-term uncertainty. Successful investing is a long-term endeavor and takes a patient view for planning. Investment decisions with undue attention to election outcomes is not smart. At best, positive years may be due to random luck. At worst, you can miss returns easily gained by simply staying in your seat and remaining invested.

While investing is always uncertain, there is at least one certainty: to capture market returns, you must minimize costly mistakes. To do that, one rule is to remain invested over many years, because negative years will happen. Have a sufficiently informed allocation strategy suitable for your risk preference and a willingness to be patient. With the right planning professional and time horizon, your outcomes can yield a successful financial experience and confidence for your peace of mind.

NOTES

¹Hannan Miao, Wall Street Journal (October 2, 2022), 11664660238.

²This is known as the efficient market theory, which postulates that market prices reflect the knowledge and expectations of all investors and new information is almost instantaneously priced into a security.

³For instance, only 18% of US-domiciled equity funds and 15% of fixed income funds have both survived and outperformed their benchmarks over the past 20 years. The Mutual Fund Landscape 2022, Dimensional Fund Advisors. That survey is updated annually and results have been reasonably consistent for over a decade.

⁴Examples include: “A Trump win would sink stocks. What about Clinton?” CNN Money, 10/4/16, “What do financial markets think of the 2016 election?” Brookings Institution, 10/21/16, “What Happens to the Markets if Donald Trump Wins?” New York Times, 10/31/16.

⁵Dashes representing returns for a given month are stacked in ascending order of return within each column, with highest return within that range on top. Gray boxes represent non-election month returns.

September, 2022

A frequently voiced argument against value investing stems from opinions expressed in the media and elsewhere that we’re in a “new normal” environment where stocks in innovative or high-tech companies have an investing advantage over “old guard” established industries, such as energy or financials.

Until recently, FAANG stocks were a poster child for this argument; those behemoth technology companies have contributed substantially to much of the market’s overall return during the last decade. By virtue of their status as growth stocks, they even caused negative value premiums to occur. From January 2010 to December 2020, the five FAANG stock outperformed the Russell 3000 US Market index by 13.6% a year! Who wouldn’t want that?

However, from January 2021 to December 2021 we find that FAANG outperformance over the Russell broad US market index reduced to only 3.3%. Recently, from January 2022 to the end of June 2022, Netflix declined 71.0% and Meta (formerly Facebook, the “F” in FAANG with Netflix as the “N”) declined 52.1%. Amazon declined 36.3% and Google dropped 24.7%. Nobody wants that.

Consequently, during their annual reconstitution event, Russell reclassified mega firms Meta and Netflix from “growth” to “value.” It’s ironic that 40% of the pillars used to support media growth arguments inimical to a value investing approach have now metamorphized into value stocks themselves.

This highlights a common misconception about the character of “value investing.” A “value premium” is best understood as the discount-rate relative to business financing. Expected cash flows for all companies over their likely futures, as reflected in constantly changing market prices, are not identically discounted. Firms with stock prices low relative to their expected future cash flows tend to have higher expected returns for investors willing to hold their shares. This is not true of FAANGs.

Those emphasizing the advantages of investing in expanding growth firms, such as FAANGs, inadvertently are making a case for applying a lower discount rate for those firms’ expected cash flows. All else being equal, such as with soaring FAANG stock prices, greater certainty around continued company success should be associated with lower expected returns for investing outcomes! Those seeking better opportunities for high returns on their capital will be turning their attention elsewhere since all that good news is in the price of those shares. That a big drop in FAANGs finally occurred, triggered by unexpected bad news, is not surprising based on capital market theory.

Exhibit 1 shows that for companies which have grown to become among the largest based on market capitalization, once positioned within that group, should be expected have much lower future market returns (on average), more aligned with the broader market indexes. Thus, those forecasting perpetually good future returns due to past company success, should reconsider whether equating the company growth they expect with high stock returns going forward is sensible.

Exhibit 1: What Have You Done for Me Lately?

Average outperformance of companies before and after becoming one of 10 largest

In USD. Data from CRSP and Compustat for the time period 1927-2021. Average annualized outperformance of companies before and after the first year they became one of 10 largest in US. Companies are sorted every January by beginning of month market capitalization to identify first time entrants into the top 10. Market defined as Fama/French Total US Market Research Index, a value-weighted US market index sourced from CRSP, dividends reinvested in paying company until portfolio is rebalanced. The Fama/French Indices represent academic concepts that may be used in portfolio construction and are not available for direct investment or for use as a benchmark. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Index has been included for comparative purposes only. Compared to Fama/French Total US Market Research Index, 1927–2021. Past performance is no guarantee of future results.

Volatile Markets Don’t Help Active Managers

Active managers frequently claim that they do best in times of high market volatility. This may sound like an emotional hedge akin to having its payoff for betting against your favorite sports team. However, a careful study of active US-domiciled equity funds finds no meaningful relation between market volatility and an improvement in managers’ success rates. Rather, it appears that traditional active investing actually compounds concerns in bad times.

The rolling three-year standard deviation for US stock market returns, illustrated by the orange line in Exhibit 2, shows recent volatility at its highest level since the 2008 global financial crisis. The rolling three-year outperformance rates of active US equity funds (blue bars, notably almost all much less than 50 percent) imply very little relation with volatility levels. The high year-to-year variation in success rates does not consistently track market volatility. For example, rolling averages of daily volatility from 2014 to 2019 were level, yet the percent of funds outperforming during these rolling periods was not, ranging from 23% to 37%. We doubt those outcomes will improve going forward.

Exhibit 2: Active Imaginations At Work

Rolling three-year outperformance rates for active US equity funds vs. stock market volatility January 2005 – December 2021

Market volatility computed each month using standard deviation of Fama/French Total US Market Research Index daily returns. Monthly volatility observations are then averaged over rolling three-year periods formed at the end of each year. Outperformance rates are computed over the same rolling three-year periods and are calculated as the percentage of active US-domiciled equity funds that survive the period and outperform their respective Morningstar category index net of all fees and expenses. Sample of active managers consists of funds categorized as active US equity by Morningstar. Fund returns are average returns computed each month, with individual fund observations weighted in proportion to their assets under management (AUM). Index benchmarks are those assigned by Morningstar based on the fund’s Morningstar category. Past performance is no guarantee of future results.

Confidence in Your Planning

Volatile market environments cause enough worries – erratic outcomes only add to them. Traditional managers and quants always make predictions or back test simulations. Dimensionally structured strategies don’t try to outguess markets and are not constrained by arbitrary index parameters. Instead, we rely on information in market prices, and apply a scientific, transparent, and process driven approach that systematically pursues higher expected returns in our portfolios with low-cost, diversified solutions. By closely aligning your personal retirement income and legacy goals and preferences with your investing, you can have much greater confidence in outcomes you plan for tomorrow, and the greater your family’s peace of mind can be today.

August, 2022

KEY TAKEAWAYS

• A continuous and careful value focus best positions you to capture value premiums when they appear for a greater expected return than focusing on growth stocks.
• Value stocks have surged in the past year, but the resulting performance lift has varied widely across active value managers.
• The relative outperformance of Dimensional portfolios since 2020 reflects a superior management process to deliver on value exposures.

Value is an asset class, not an investment strategy. Identifying low relative price stocks is only one step toward effectively designing and structuring value tilted portfolios. Moreover, differences in managers’ implementation can lead to a wide range of value outcomes in active portfolios.

For systematic investing through Dimensional Fund Advisors, very strong value performance during periods of value outperformance signals a superior ability to reliably capture value premiums. However, only those investors remaining invested during a preceding slump are likely to be fully rewarded. Greater relative outcomes are much more likely for those with consistent equity value allocations.

Swings in Equilibrium

For several years, growth stocks strongly outperformed value stocks. Some speculated whether evidence for a value premium was still valid. The three-year period ending June 2020 was the worst recorded for the US value premium. The Russell 1000 Value Index underperformed the Russell 1000 Growth Index by 17.2 percentage points annualized. This was unprecedented. Of the 1,093 rolling observations in US history, the three years ending in June 2020 ranked dead last. That is the very definition of an outlier.

Since June 2020, value has made a decisive comeback, beating growth by 8.1 percentage points annualized through June 2022. Historically, value stocks have outperformed their growth counterparts by 4.1 percentage points on average in all years from 1927 to 2021, as Exhibit 1 illustrates.

Exhibit 1: Yearly Observations of Value Premiums

Value minus Growth in US Markets (1927 – 2021)

In US dollars. In US dollars. Yearly premiums are calculated as the difference in one-year returns between the two indices described. Value minus growth: Fama/French US Value Research Index minus the Fama/French US Growth Research Index. Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

To suggest that the value premium no longer exists based on a short 3-year period abandons a sensible economic theory — the valuation model: paying less today for future company cash flows is associated with a higher expected returns to be realized in the future. The firm’s cost of capital is the investor’s return.

Investor outcomes through the last decade negatively impacted a strong value emphasis. However, we know the more a portfolio methodology deviates from a strict market weighting like an index fund, the greater the tracking error relative to the market that may occur from time to time — but the greater the expected outperformance when targeted value premiums finally do reappear.

A Difference of Opinion

Extensive research from Dimensional’s team shows over and over that a value emphasis reliably increases portfolio expected returns for long-term planning. Research further suggests that a positive value premium can occur regardless of good or bad value performance in the prior year. Exhibit 2 illustrates this.>

Exhibit 2: Annual Value Premium and Following Year Value Premium

US Market (1927 – 2021)

Past performance is not a guarantee of future results. Actual returns may be lower. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio. In USD. Annual value premium is the return difference between the Fama/French US Value Research Index and the Fama/French US Growth Research Index. Yearly premiums in top chart are arranged from low to high rather than chronologically, covering 1927-2021. Premiums in bottom chart are arranged in the order of the top chart, but one year later in each instance, to show next-year performance.

The exhibit looks at the value premium’s performance from one year to the next. Years are arranged based on annual value premium, and then compares the next year’s performance. The top quartile years — those with the strongest value premium performance — were followed by an average annual value premium of 4.74%. The bottom quartile — or the weakest years for the value premium—on average were followed by an annual value premium of 4.35%. The average differences are not much.

It’s very important to point out how often active managers don’t capture the full return. Within Morningstar’s value category, exposure to low relative price (“value” stocks) varies substantially across funds. For example, the 200-plus funds in Morningstar’s large cap value category over the 10-year period ending March 31, 2022 had fund price-to-book ratios ranging from 1.3 to over 6.6. Such a wide variation means that those “value” funds had inconsistent exposures to value. In months when the Russell 1000 Value Index outperformed the Russell 1000 Growth Index, the average monthly net return for these funds ranged from 0.41% to 2.44%. Such fund uncertainty is not acceptable for anyone’s planning.

Buyer Being Aware

Informed planning invests in a way that puts the odds in your favor. There’s never a “right” or “wrong” time for value investing. Varying value premium tilts during a period of disappointing underperformance may forfeit part or all of a future value rebound. Similarly, we can’t predict how long current value outperformance will continue. What we do know is that one key thing an investor can control is to decide to stick with their investment policy.

The Dimensional solutions that Professional Financial employs systematically target value stocks, day in and day out. We expect a positive value premium for clients every day. While frequently daily realized premiums will be negative, bearing those occasional negative premiums is the price an investor must pay.

A disciplined allocation targeting value stocks for investing boosts the odds your portfolio will deliver on that premium when it materializes. Sticking with a professionally informed approach, sensibly diversified, especially one based on the science of capital markets, we believe is the best approach for most families to confidently plan successful outcomes with their hard-earned life savings in the face of all the uncertainty we must endure today in a changing world that is constantly in flux.

Source: CRSP and Compustat data calculated by Dimensional. Fama/French data provided by Fama/French. Fama/French US Value Research Index: Provided by Fama/French from CRSP securities data. Includes the lower 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). Fama/French US Growth Research Index: Provided by Fama/French from CRSP securities data. Includes the higher 30% in price-to-book of NYSE securities (plus NYSE Amex equivalents since July 1962 and Nasdaq equivalents since 1973). This information is intended for educational purposes and should not be considered a recommendation to buy or sell a particular security. Returns for 2021 are through the year-to-date period ending November 30, 2021. Returns less than one year are not annualized.

July, 2022

When you consider reducing your stock allocation due to bear market pain, balance the regret you feel as markets go down with the regret of missing out when things turn around.

Today people we know are worried about so many things. Prices are up for necessities like food or gasoline. Markets along with investment accounts are down. Interest rates are rising making major financial decisions like house buying difficult. Added to this is stress you may feel due to your job, the unending pandemic, and the health of loved ones.

If non-stop media news about market volatility has you stressed about your investments, then it’s time to review how our way of investing can give confidence and peace of mind even in times of bear markets.

First, there is no safe way to get a high return. Good planning will prepare you for times when market prices unpredictably fall; plan design takes that into account. Good planning also prepares you for sudden market rises — very often, unexpectedly when things seem only to be getting worse. We believe education from good planning, professionally done, should keep you willing to be invested even during stressful times.

But investing strategies cannot be the same for everyone. Each of us has a different situation. Our goals are different. Where we live is not the same. Our stage in life is different. How people tolerate risk depends on how their brains are wired, how secure their jobs, and what experiences they have endured over their lifespans.

After my mother had a serious stroke, I went to bank after bank finding her accounts only earning 2 or 3 percent interest. Mom, unlike Dad, didn’t listen much to my advice. But Mom had lived through the Depression and grew up on a north Texas dirt farm. Years later she helped our family survive a financial crisis after my father had a spinal injury while in service that ended a Naval career dating back to World War II.

The few stock or mutual fund stock investments Mom ever had, never lasted long even though she made money each time. She did what she needed to feel safe, based on the life she had lived. Mom always lived frugally and even continued to work until she was 70. She reminisced about the good old days of the 1980s when banks paid double digit interest rates when inflation was higher than today.

That’s not my plan, but it was hers. Everyone is different.

Investing during volatile times

Everyone who invests will have ups and downs in their personal portfolios. So how will you plan for volatility?

First, answer the question, “Why are you investing?” It’s not a plan if you haven’t declared goals, goals you truly care about. If you want to retire comfortably in 30 years, you likely are able and must bear more risk to maximize the growth of your portfolio over such a long time than you would if you intend to retire three years from now. Regardless you still must save regularly.

Then, determine what balance of bonds and stocks within diversified portfolios makes sense for your planning goals and is comfortable for you. If you choose a lower proportion for equity allocation, you may feel better when markets go down, but you must balance that sense of relief with feelings of missing out on growth opportunities as businesses recover and markets go up, usually far more than they previously declined.

Lastly, focus your efforts on controlling what is under your control — like saving more and spending less, or keeping taxes lower.

When you find yourself tempted to change, consider whether you’re simply exchanging one long-term strategy for another — in effect, a perverse form of market timing. Trying to time short-term market moves by attempting to avoid losses has more in common with speculating than with building wealth.

When I look back over my past 40 years of investing, I can make a long list of all the surprising shocks that caused financial markets to go down. People complain about higher interest rates today, but I remember buying a house in Fairport with a loan that had a 12% interest rate back in the 1980s. I didn’t like it, but I didn’t have a choice if I wanted to buy that house.

We must accept that economic shocks will happen again and again. Rather than trying to predict them, we should prepare for them. This time in the aftermath of Covid lockdowns, there is inflation, fear of a recession, increased market volatility, Russia making war. We can’t know when the aftermath of this shock will end, or when the next one will occur. The only guarantee I can offer you is that what happens as it impacts the markets is going to be a surprise — because if it weren’t, markets would already have incorporated that event in the aggregate of stock prices that comprise those markets.

The High Cost of Timing Gone Wrong

The negative impact of market timing gone wrong, even over short periods, can be surprisingly large, as shown by the hypothetical portfolio below made up of the Russell 3000 Index, a broad US stock market benchmark.

A hypothetical $1,000 investment made in 1997 would have turned into $10,367 for the 25-year period ending December 31, 2021. Over that same period, if you miss the Russell 3000’s best week, which ended November 28, 2008, the value shrinks to $8,652. Miss the three best months, which ended June 22, 2020, and the total return dwindles to $7,308. We have former clients who made each of those mistakes.

Exhibit 1: What Happens When You Fail at Market Timing

Russell 3000 Index of US Stocks, Total Returns For Selected Periods Over Past 25 Years

Past performance, including hypothetical performance, is not a guarantee of future results.
In US dollars. For illustrative purposes. Best performance dates represent end of period (Nov. 28, 2008, for best week; April 22, 2020, for best month; June 22, 2020, for best 3 months; and Sept. 4, 2009, for best 6 months). The missed best consecutive days examples assume that the hypothetical portfolio fully divested its holdings at the end of the day before the missed best consecutive days, held cash for the missed best consecutive days, and reinvested the entire portfolio in the Russell 3000 Index at the end of the missed best consecutive days. Data presented in the Growth of $1000 exhibit is hypothetical and assumes reinvestment of income and no transaction costs or taxes. The data is for illustrative purposes only and is not indicative of any investment. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio.

Although many advisors claim otherwise, there’s no evidence that market timing can be done successfully — that is, targeting the best days or moving to the sidelines to avoid the worst. Our experience strongly suggests staying put through good times and bad. As we see in our example, missing only a brief period of strong returns can negatively impact previous performance enormously. A disciplined approach with a sensible diversified portfolio strategy not only better positions you to capture what financial markets have to offer, but greatly lessens that troublesome worry about missing out when markets eventually, but unpredictably, make their major turn upward once again.

Clients who evaluate their accounts in terms of decades when investing rather than months or years have the greatest chance of capturing the power of markets as they compound wealth. Capturing relatively small extra gains consistently adds up over time. This helps explain why over the past 95 years for which we have reliable data (with periods of many shocks like the recent one), the return for the broad U.S. stock market has been around 10% a year.¹ Markets rarely return 10% in any one year. But long-term investors focused on a diversified portfolio have been rewarded with something like that long-term average. However capturing such a return invariably meant enduring and holding on through tough times like today.

Conclusion

We don’t know how long today’s big bear market will last. Based on how I read the continuing news reports as a CFP® professional, I think that stocks are on sale and rebalance my portfolio to targets I planned:

• Bonds have become 10% cheaper in the past six months.
• Emerging market and international stocks got 18% and 19% cheaper, respectively.
• Large U.S. stocks have become 20% cheaper.
• A major index of smaller stocks got 23% cheaper.
• Big growth stocks got 28% cheaper.

Since most manager’s efforts to actively outguess changes in market prices will result in underperformance most of the time, here’s good news you can use: You can reliably capture market return without the futility of forecasting or vainly searching for someone who can — just follow Professional Financial’s wealth planning process.

Over my long career, so many people have been enriched from creating a sensible plan they could stick with. Nothing is easy, but financial planning is the best way I know to invest successfully for the long-term. We apply one philosophy using strategies grounded in financial science that dates back decades. To deliver a better investing experience for you, we use the accumulated expertise, judgement, and skill of some of the smartest people in finance around to help us make well-informed decisions in these tough times.

Through time, we’ve experienced a wide range of markets and the business cycles they encompass. Clients have stayed with us, and our firm grew as their portfolios grew. We recognize that every dollar invested through us represents their hard work, savings, and dreams for their future and for their families. We deeply appreciate the trust clients have placed in us for so many years and do our best to honor that trust.

^1.In US dollars. S&P 500 Index annual returns 1926–2021. S&P data ©2022 S&P Dow Jones Indices LLC, a division of S&P Global.