A year ago, at the end of March 2020, the S&P 500 was down nearly 20%1 and the world was going into lockdown. Many experts and economists wrote about where we would be in a year. I don’t remember anyone predicting that the S&P 500 Index would be up 56% only 12 months later or that the broad U.S stock market be up over 62%. But that’s what happened.
I avoid making forecasts. Researchers examining how stock markets responded after past recessions have learned almost nothing useful. We should simply expect severe market downturns occurring once or twice a decade, while accepting the “old normal” that we can never know when or how much that will be. Diversified investors are rewarded for their willingness to endure risk, not to avoid it.
What lessons can be taken away from last year that will better prepare you for the next time? People say, “It’s different this time.” They’re right. It is different every time. Arbitrary government decisions fearing many pandemic deaths precipitated a market crisis. The first crisis I recall was in the 1970s: inflation, oil, and Vietnam. Then there was the savings and loan crisis, Black Monday, the Asian contagion crisis, the dot-com bubble, 2008 financial panic, and recently the Christmas stock massacre. The list will not end. Every market crisis is unexpected. Crises keep occurring because the events triggering them aren’t predictable. If market downturns were predictable, stock market prices would have already adjusted. That’s inherent in the nature of forward-looking price-setting in well-functioning capital marketplaces everywhere around the world.
No one can predict when the next “black swan” event will trigger a market crisis. But you should thoughtfully structure your investment planning well before that occurs. The first principles of addressing uncertainty of stock and bond market outcomes is considering the likelihood of various outcomes, and then deciding how much volatility you can tolerate. We can’t control what crises occurs, but we can control our emotional response by having a smart strategy in place. You need a systematic process guided by a trusted advisor that will keep your emotions in control even when events seem out-of-control. This is the “next normal” for you.
For clients of Professional Financial who stuck with their planning and suffered the pain, it’s time to celebrate the gain. For instance, Dimensional’s US Core Equity 2 Portfolio, which holds a diversified mix of U.S. equities and is their largest core portfolio, returned nearly 72%, as Exhibit 1 shows. Within the U.S. market, small cap value stocks2 were among the hardest hit in the crisis. Dimensional’s concentrated US Small Cap Value Portfolio was down 39% in the first three months of 2020 but subsequently returned a showstopping 112% over the next 12 months. (The broader US Vector Equity Portfolio with substantial small value stock positions was up 84%.)
Exhibit 1: Rise and Shine: Dimensional Funds vs. Benchmarks
Cumulative Returns
Performance data shown represents past performance and is no guarantee of future results. Current performance may be higher or lower than the performance shown. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. To obtain performance data current to the most recent month-end, visit us.dimensional.com.
Sticking to long-term planning strategy in the face of an unprecedented situation wasn’t easy. Last March stressed everyone. There was enormous social and media pressure to “do” something. Many retired and near-retirement investors have come to hold very substantial positions in stocks, ETFs or alternatives. They believe that market-based securities are their best income option to low returning bank CDs or government bonds. Inexperienced investors, as stocks and even bonds dramatically declined and internet media played on their fears, quickly cashed out to reduce their uncertainty.
Investors realized only too late that selling out to “protect their principal” only increased their uncertainty. Holding cash and seeing fixed on the latest news, they are forced to make a second even more difficult decision: choosing the best time to get back in. By putting off that decision until the newscasts signaled that investing was “safe,” most of what those sellers previously earned from investing had disappeared.
The price of a market education is very high. Many who “invest” in risky assets are gambling. If you’re trying to time short-term market movements or picking stocks or ETFs, you’re gambling. You are betting that you know more than the smartest market participants with the fastest computers. Would-be gamblers must never forget—in the end, the house always wins. Getting rich quick by luck doesn’t mean you stay rich.
Staying focused on long-term expected outcomes during any challenging time is hard. Investing on your own is hard. Watching the daily market movements of 2020’s horrible first quarter gave no signal of astonishing returns yet to come. Future returns after the end of March could not be known, and we surely did not know.
But based on decades of research and experience, we knew that the only hope of a successful financial outcome from the crisis was maintaining a consistent risk exposure through dimensional-style allocation strategies, planned well in advance. Only then could clients confidently hope to capture their share of returns whenever they eventually showed up. And show up they did, big time. Those who stuck with their planning philosophy and process, got far more of their share of gain than they ever expected—putting them comfortably back on track for financial and retirement lifestyle goals.
Our role as CFP® professionals — trusted fiduciaries who put your best interests first and foremost — is informing you of possible planning outcomes when developing, structuring, and managing a wealth strategy tailored to your unique values, goals, and preferences. In putting a plan in place, you need to be realistically confident of a reliable range of results so you can safely ignore the news media. The oldest media trick to gain viewership is playing on your deepest fear of dying broke. Wealth management that Professional Financial provides accounts for extreme challenges that you may face, so you may have peace of mind, knowing the difference between investing and gambling.
What is the Next Normal? It’s expecting uncertainty in the normal course of investing. It’s committing to strategy with a plan and process that incorporates those possibilities. It’s positioning you to rise above the temptation to make reactive changes in tough times. And it’s knowing how great it feels to experience successful financial outcomes again and again, so that you and your family can look forward with confidence, rather than fear.
If you are not confident that your strategy considers the unexpected and uncertainty in its range of planning outcomes, and were not happy last year, it may not be too late. Perhaps the crisis was an expensive learning experience. Worse may still come. But true wealth management that we provide prepares you not only for living in the New Normal, but just as important, prepares you to experience the Next Normal with confidence.
Exhibit 2: Performance as of March 31, 2021
RISKS: Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
- S&P data © 2021 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. Increase of 56.35% was from March 31, 2020–March 31, 2021.
- As defined by the Morningstar Small Cap Value Category.