Another update on the markets - DRW Financial

This post seeks to share some insight about the current state of the markets and economy, as well as some ideas on how to make the best of this moment.

Volatility is here!

As of this writing, on June 16, 2022, the S&P 500 is down about 24% from it's highest level, which was set on January 3 of this year.  The 10 year US treasury yield is around 3.31%, which is more than double the level is traded at the start of the year.
In the simplest terms, these two points taken together mean that almost any portfolio built of funds that track the stock and bond markets are likely to be "down" in value over the last ~ 6 months.

Some broader context may be useful here.  Considering the current level of the S&P and the level in mid June 2017, for roughly 5 years of data, the compound annual growth rate of the index is still around 8.4%, and that is excluding dividends.  So an investor holding a broad basket of stocks over the last 5 years, annual returns have probably been decent, even with the current downturn.

However, it is never fun to see portfolio values drop, and the current level of market volatility is something we have not seen in a while; the image below shows the level of the "VIX", one measure of market volatility, over the last 5 years:

The tallest peak in that range was the March 2020 market crash at the outset of the COVID-19 disruptions, and the market is creeping back towards that level of volatility.  Volatility in the markets is not necessarily bad, but it can be uncomfortable to watch.  When things are going well, it is normal investor psychology to think that the markets are an intelligent machine, constantly calculating value, but my perspective has come to view the markets more like a drunk college freshman trying to find their way back to the dorm...they will probably get to the right place eventually, but will likely stumble and sway along the way.  This is particularly the case in the short run, which is why my firm's approach to financial planning and investment attempts to match portfolio advice to the time horizon for a given goal.

Young folks who are well employed and have decades to save for retirement are generally able to weather some bouts of market volatility along the way; people close to or in retirement may have circumstances that dictate they are less comfortable having as much exposure to that volatility.

What's coming next?

I continue to hold the line that the future is hard to see, and the best we can do is prepare based on the things we do know now.

• Spending less money than we earn should produce multiple benefits, including the accumulation of savings and the cultivation of a more financially sustainable lifestyle
• Holding an emergency fund in cash to cover normal and some amount of extraordinary expenses for a few months can help buffer against financial surprises
• Recognizing that "leverage", in the form of borrowed money, typically increases our experience of volatility
• Clearly articulating, prioritizing, and pursuing financial goals with appropriate investments increases our opportunity of success

Market history does not necessarily imply or inform the market's future, but there are some things we can learn from the past:

• Diversification of assets (stocks and bonds and real estate and XYZ) can help moderate the experience of volatility.  This kind of diversification can come at a cost in up markets, but often cushions portfolio values somewhat in down markets.
  
• Diversification within assets (holding dozens or hundreds of companies' stocks, for example, rather than just a few) decreases the risk of one company having an outsized impact on a portfolio.  A timely example may be Twitter, whose stock reached 77 in February 2021 and is trading at ~ 37 today, for a roughly 50% loss from that high (Neither I nor my discretionary investment management clients own shares in Twitter directly, nor do I have an analytical opinion on the stock at this time).
• Over time, the stock market tends to reward companies (and their investors) who consistently earn profits

Opportunities here?

There are a handful of things that may make sense to consider in this market moment, and I welcome the opportunity to discuss these with my current and prospective clients one on one:

• Take money off of the sidelines -- if cash has accumulated above and beyond a prudent emergency reserve, there are likely to be new and increasingly attractive opportunities for investment in the current market
• Review tax tactics and strategies -- the tax code provides some opportunities to realize a benefit from a realized "capital loss", which basically means selling something for less than it cost.  In some cases, this can open up opportunities to lower income taxes, or to pair off against investments trading with unrealized capital gains...
• Consider converting traditional IRA balances to Roth -- in simple terms, doing a "Roth conversion" adds taxable income in the current year, but may mean that future distributions from the Roth in retirement are "tax free".
  Taking advantage of a down market could mean doing a conversion that introduces less income tax now with the hope of higher asset balances later.
  For one example, consider a traditional IRA that was worth $100k before the market sell off; a conversion done then of 10% of the account would produce $10k of income.  If the account has fallen to $85k now, a 10% conversion would only produce $8500 of income in the current year.  All else equal, if the market does bounce back higher, this sort of conversion could be opportunistic
  
• Revisit financial planning considerations -- if this market movement surfaced or illuminated thoughts or concerns about goals, finances, risk...this is a perfect time to work through those with your financial planner.