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As Volatility Continues, Here Are the Potential Costs of Market-Timing

The Potential Costs of Market-Timing

As stock market volatility continues into the second half of the year, many investors are growing increasingly concerned about their investment portfolios. Many have already fled the market for the perceived safety of cash. Yet market-timing is often more costly than sticking to your investment plan in turbulent times.

Indeed, long-term investors benefit from equities because of the higher returns they generate over time. This growth is necessary to outpace inflation, so that your dollars maintain their value well into the future. However, growth comes at a cost. Meaning, investors must endure periods of discomfort to successfully achieve their goals.

Naturally, staying the course may be easier said than done, especially as your account balances decline. At the same time, it’s important to remember that paper losses aren’t permanent—unless you decide to sell.

Before you let your emotions get the better of you, consider the potential costs of market-timing:

#1: The average investor consistently underperforms the broad market due to poorly timed trades.

Successful investors aim to buy low and sell high. Yet research shows that in practice, the average investor does just the opposite. Dalbar’s annual Quantitative Analysis of Investor Behavior report repeatedly shows that across time horizons, investors tend to consistently underperform broad market benchmarks by wide margins.

For example, the average equity investor earned an annualized return of 7.13% over the last 30 years through 2021. Meanwhile, the S&P 500 Index generated an annualized return of 10.65% over the same period. That means the average investor underperformed the market by about 3.5% annually over 30 years. According to Dalbar, the disparity in results can largely be attributed to investors buying and selling at the wrong times. 

#2: Market-timers are more likely to miss out on market rebounds.

When the S&P 500 dropped 34% from peak to trough at the beginning of the Covid-19 pandemic, many investors panicked. Fortunately, that bear market was surprisingly short-lived, lasting only 33 days.

The S&P 500 subsequently gained 75% over the next year. Investors who stayed the course were rewarded handily, while those who sold prematurely locked in their losses.

Research shows that while the duration and magnitude of bear markets vary, they tend to share one commonality: the recovery in the first year tends to be significant. Though no one can predict the future, there’s no reason to believe this time will be different.

#3: Deviating from your investment plan may keep you from reaching your financial goals.

No one likes market volatility. Nevertheless, when you expect it, you can plan for it. While your investments may lose value from time to time, a sound investment plan is designed to help you successfully reach your financial goals.

However, deviating from your investment plan can undo years of progress towards your financial goals. While the potential consequences of market-timing may feel abstract now, they can have a very real impact on your quality of life down the road.

How to Avoid Market-Timing in Turbulent Times

Keeping your emotions in check can be challenging—especially when it comes to your money. The good news is there are steps you can take to avoid the potential costs of market-timing.

First, be sure to set clear and realistic financial goals. Aiming too high can lead you to take on excess risk to close the gap between where you are now and where you want to be.

In addition, don’t let market activity be a reason to change your investment approach. Instead, focus on the things you can control—for example, your asset allocation, investment costs, and spending habits. Furthermore, make sure your investment portfolio is properly diversified. This may help smooth the ride over time as markets fluctuate.

Lastly, consider working with a fiduciary financial advisor like Sherwood Wealth Management who can help you develop a long-term investment plan that’s aligned with your risk tolerance and goals. We can also help you stay the course when your emotions begin to get the better of you. To get started, schedule an introductory phone call.

Rising Interest Rates and Your Portfolio

Rising Interest Rates and Your Portfolio

If you’re unsure how rising interest rates may impact your investments and overall wealth plan, here’s what to look out for and how you can prepare accordingly.

For over two years, the Covid-19 pandemic has presented a variety of new challenges to our health, lifestyle, and the economy. As the pandemic wanes, we continue to feel the impact of ongoing labor shortages and supply chain disruptions.

One of the most pronounced effects of the pandemic in recent months is record-high inflation levels. As a result, the Federal Reserve announced their first interest rate hike since 2018 in March, and economists expect several more increases this year.

Indeed, many of us have grown accustomed to near-zero interest rates. If you’re unsure how rising interest rates may impact your investments and overall wealth plan, here’s what to look out for and how you can prepare accordingly.

#1: Rising Interest Rates and Your Real Estate Portfolio

The federal funds rate influences the prime interest rate, which lenders use to determine interest rates for credit cards and other loans, including mortgages.

Up until recently, mortgage rates have been relatively low for borrowers with strong credit. However, earlier this month, the average rate on the popular 30-year fixed mortgage crossed 5% for the first time since 2011 (except for two days in 2018).

For some people, rising mortgage rates may add to the pain of an already hot housing market. If you have the resources, you may want to consider paying off mortgage debt ahead of schedule to eliminate the expense entirely. Alternatively, refinancing may help you lock in a lower fixed rate before interest rates potentially soar higher.

#2: Rising Interest Rates and Your Bond Portfolio

In general, bond prices fall as interest rates rise (also known as interest rate risk). As governments and private companies issue new bonds at higher rates, old bonds become less attractive and therefore lose value.

Not all bonds are equally sensitive to interest rates. Interest rate sensitivity is measured by duration; the longer a bond’s duration, the more sensitive its value is to changes in interest rates. One way to reduce interest rate risk in your bond portfolio is to shift towards shorter duration bonds.

However, if you have a longer time frame to invest, you may not want to make any changes to your portfolio. As your bond holdings mature, you can reinvest them at higher rates in the future.

It’s also worth noting that higher yielding and lower quality bonds tend to be less sensitive to interest rate changes. Of course, these types of bonds can introduce other risks to your portfolio. So, be sure to do your homework first.

#3: Rising Interest Rates and Your Stock Portfolio

It’s cheaper for businesses to borrow expansion loans when rates are low, which is generally seen as favorable for the economy. On the other hand, the prospect of rising interest rates typically signals slower economic growth. This, in turn, tends to spook equity investors (at least temporarily).  

At the same time, bonds and cash often become relatively more attractive as interest rates rise. This can cause stocks to lose value as demand shifts from equities to income-generating securities. And as personal debts become more expensive to service, consumers tend to spend less, further driving down stock prices.

You may not want to abandon your equity investments altogether. However, a diversified portfolio can help mitigate potential volatility as interest rates rise.

#4: Your Savings

With interest rates close to zero for the last several years, savers have earned virtually nothing on cash. Currently, the average savings account interest rate is 0.06%, according to Bankrate’s weekly survey of institutions.

One benefit of rising interest rates is that you may earn a higher rate of return on your cash. Just don’t expect a dramatic change immediately. Deposit rates are typically much slower to respond to changes in the federal funds rate.

Bottom Line: Don’t Panic

With rates at historic lows for so long and inflation at record highs, it’s no surprise that a new rate hike cycle is underway. If you have a disciplined wealth management plan, there’s no reason to panic. Interest rates tend to be cyclical and will eventually return to more normal levels.

If you don’t have a plan for your wealth, you may want to consider working with a trusted advisor like Sherwood Wealth Management. A long-term plan can help you navigate the inevitable ups and downs of the market. And it can help you successfully weather periods of uncertainty. To get started, please schedule a complimentary consultation.

3 Ways to Make a Greater Impact with Your Wealth

3 Ways to Make a Greater Impact with Your Wealth

If you’re the beneficiary of a windfall, a prudent first step is to develop a financial plan to ensure you can meet your day-to-day financial obligations and long-term goals. However, affluent individuals and families often have more altruistic goals for their wealth, as well. Fortunately, there are many ways you can effect change by strategically directing your money to organizations and businesses that share your values. Whether your objective is to change the world, shape your legacy, or simply lower your tax bill, here are three ways to make a greater impact with your wealth.

#1: Support Local Businesses

Shopping local is a great way to strengthen your community by boosting the local economy and providing jobs for residents. In fact, for every $100 spent at small businesses, $48 is put back into the local economy, according to data from Intuit Mint. Furthermore, the Small Business Administration reports that small companies create 1.5 million jobs annually and account for 64% of new jobs created in the United States.

In addition, shopping local can help reduce reliance on larger chains with less commitment to their communities. These larger corporations may also have less responsible business practices than the businesses in your community. If you want to make a greater impact with your wealth, supporting local businesses is a great place to start.

#2: Give Strategically

Americans tend to be very charitable. Indeed, charitable giving accounted for 2.3% of gross domestic product in 2020, according to National Philanthropic Trust. Moreover, 86% of affluent households maintained or increased their giving in 2020 despite uncertainty about further spread of COVID-19.

Despite our charitable tendencies, most of us fail to measure the impact of our gift after writing the check. Fortunately, you can make a greater impact with your wealth by giving more strategically.

For example, donor-advised funds (DAFs) are an effective and easy way to financially support the causes most important to you. DAFs have exploded in popularity in recent years. In 2020, assets totaled $142 billion, according to the 2020 Donor-Advised Fund Report. DAFs are set up within a charitable organization such as a community foundation. Among other benefits, they offer increased flexibility and efficiency over many other charitable giving methods.

#3: Invest with a Purpose

Environmental, social, and governance (ESG) investing is becoming increasingly mainstream among investors who want to do well by doing good. According to research from Bloomberg, global ESG assets are on track to exceed $53 trillion by 2025, representing more than a third of the $140.5 trillion in projected total assets under management. 

There are many ways to invest with a purpose. Impact investing, socially responsible investing, and green investing are just a few examples. These strategies allow investors to support companies with responsible business practices while earning a positive return.  If you wish to make a greater impact with your wealth, aligning your investment dollars with your values can help you achieve this goal without sacrificing financial gain.

A Trusted Advisor Can Help You Make a Greater Impact with Your Wealth

Wealth can help you achieve many goals, from providing financially for loved ones to effecting meaningful societal change. If you would like to make a greater impact with your wealth, a trusted financial advisor can help you develop a plan to ensure your efforts are effective.

Sherwood Wealth Management specializes in the unique financial planning needs and objectives of sudden wealth beneficiaries. If we can help you develop a plan for your newfound wealth, please do not hesitate to schedule a call. We’d love to hear from you.   

5 Tips for Better Investment Performance in Any Market

5 Tips for Better Investment Performance in Any Market

Volatility is the price equity investors pay for earning higher returns on their cash over the long term. Unfortunately, many investors can’t stomach the fluctuations of the stock market and end up making poor investment decisions. For example, investors often sell and go to cash when the market declines and subsequently fail to re-enter at the right time to benefit from its recovery. In fact, approximately 70% of the average investor’s underperformance occurred during 10 key periods since 1984 when investors went to cash at the wrong time, according to research from Dalbar. Indeed, many of the mistakes we make as investors are emotionally driven. And these mistakes can cause us to fall short of important financial goals. Fortunately, there are strategies you can use to achieve better investment performance in any market.

For better investment performance in any market, consider these five tips:

Tip #1: Diversify Your Investments

It can be tempting to chase after the best-performing investments, especially when you feel like other investors are making more money than you are. However, concentrating your assets in too few investments can leave you unprotected if markets suddenly turn. As Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked.”

For better investment performance in any market, it’s important to diversify your wealth across asset classes, geographies, and investment styles. Remember, a 20% investment loss requires a 25% gain just to break even. You may sacrifice your upside potential by diversifying, but you also reduce your downside risk. And fewer losses make it easier to build wealth over the long run. 

Tip #2: Avoid Checking Your Account Balance Too Often

Nobel Prize-winning behavioral economists Daniel Kahneman and Amos Tversky found that investors who check their account balances frequently are less willing to take on risk. This aversion to risk ultimately causes them to fall short of their financial goals. 

A healthy amount of risk is necessary to grow your assets over the long term. However, if you’re prone to panicking when markets fall, try checking your account balance less frequently. For example, check once per quarter rather than daily or weekly. It may sound counterintuitive, but paying less attention to your investments can help you achieve better investment performance in any market. 

Tip #3: Rebalance Your Portfolio Periodically 

If you’ve developed an investment strategy that’s aligned with your financial goals and personal circumstances, you shouldn’t need to make frequent changes to your portfolio. In fact, research has shown that trading too often can hamper investment performance over time.

Still, as markets rise and fall, your asset allocation can drift from its original targets. When this happens, the overall risk and return profile of your investment portfolio changes. To ensure your portfolio stays aligned with your future goals and risk tolerance–and to maximize your results over time–it’s important to rebalance periodically. In other words, realize gains from investments that have risen in value and use the proceeds to buy more of the investments that have declined in value. 

Tip #4: Control What You Can

A good part of the investment experience is outside of our control. This is why timing the market is so challenging. It’s difficult, if not impossible, to accurately predict the direction of financial markets consistently. 

Fortunately, there are some aspects of investing that are within our control–for example, fees and expenses. High investment costs eat away at returns over time, regardless of market direction. In fact, Morningstar found that the average fund expense ratio fell to 0.41% in 2020 from 0.44% in 2019. As a result, they estimate investors saved nearly $6.2 billion in fund expenses last year. Morningstar’s analysis demonstrates how simply controlling costs can lead to better investment performance in any market. 

Tip #5: For Better Investment Performance in Any Market, Consider Working with a Trusted Advisor 

Finally, working with a fiduciary financial advisor may help you achieve better investment performance. For example, a financial advisor can help you implement the preceding four strategies efficiently and consistently. 

In addition, one of the benefits of working with an advisor is that we take a proactive approach. Rather than reacting to market performance, we help you develop an investment strategy that you can stick to in any market environment. We also help you avoid impulsive decisions, like going to cash when markets decline. These seemingly simple actions can help you achieve better investment performance in any market and reach your financial goals. 

Sherwood Wealth Management specializes in the financial planning needs of sudden wealth beneficiaries. If we can help you develop and implement a personalized financial plan and investment strategy for your windfall, please contact us. We’d be happy to hear from you.