As we ring in the New Year, we see a market that seems to be hung over from a wild 2015. The party for equities ended on a high note in Q4 (with the Dow Jones up over 7% for the quarter!), but one quarter was not enough to make up for a sluggish rest of the year. The Dow Jones Industrial Average opened 2015 at 17,823, ended the year basically flat at 17,425, and rolled out of bed in 2016 with a thud, dropping below the 17,000 level on news of turmoil between Saudi Arabia and Iran, halted trading in China, and just for extra drama, a possible hydrogen bomb in North Korea.
The sentiment in the news coverage of the first few days of 2016 is correspondingly bearish. Dennis Gartman, a well-known investment newsletter editor, is convinced that stocks are turning south. Just like he was sure they were turning up late last year…right before they didn’t.
This is just one example of this season’s articles predicting market returns, interest rate movements, and even election outcomes for the coming year. Unfortunately, if you follow such advice, you may find yourself stuck with a losing strategy when the prediction doesn’t come true.
So in keeping with our fiduciary role, we won’t say anything is guaranteed—but we do have a few predictions for 2016 of our own.
Prediction 1: The “best funds for 2016” are unlikely to be the best funds for 2016.
At this time of year, writers compile top 10 lists and mutual fund companies tout their best fund for the year ahead. Unfortunately, these tend to be based on past performance, and evidence has shown time and time again that chasing past performance doesn’t work. Even though every single mutual fund prospectus includes the words, “Past performance is no guarantee of future results,” somehow few investors absorb this wisdom.
Naturally, some areas of the market will outperform others from year to year, but trying to jump in and out of these areas based on past performance is like expecting lightning to strike twice in the same spot.
As Wall Street Journal columnist Jason Zweig wrote, "Whenever some analyst seems to know what he's talking about, remember that pigs will fly before he'll ever release a full list of his past forecasts, including the bloopers."
Prediction 2: We’re not going to make predictions.
Stocks will go up, and stocks will go down. That’s about as close as we’ll get to a prediction—not because we don’t research the markets and current economic conditions, but because our long-term investment strategy does not emphasize predicting the short-term ups and downs of the future. That’s the beauty of diversification and low-cost index-based investing!
Just as there is no way to predict the future in other aspects of life, there is no indicator or algorithm that can predict the ups and downs of the market with certainty. We can make an educated guess, but it is just that—a guess. And that’s not how we make our investment decisions. However, we do know that markets go up over time (just not straight up). We like this fact much better than a guess.
Prediction 3: Diversification will be the strategy to follow in 2016.
…because it’s the strategy to follow every year. It is especially important in years where volatility increases. Diversification may very well show its worth during 2016 as we experience Fed action on rates, tremendous economic uncertainty out of China, global unrest and a national election!
Diversification smooths the effects of the rise and fall of different asset classes. For example, if international stocks underperform (as they did in 2015), steady income from bonds and dividends from stocks can help lessen the blow.
When you are diversified in an appropriate mix of asset classes for your goals and risk propensity, the rise or fall of any one particular area has less of an impact. That’s true for the upside and the downside. So while it may be less exciting to hold a well-diversified portfolio in a year where stocks skyrocket, the downside protection is worth it in years when stocks plummet.
Academic research backs this up. In his Nobel Prize award-winning studies of efficient frontier investing, economist Harry Markowitz showed that for two portfolios with the same average rate of return, the one with lower volatility will yield a higher compound return over time.
Prediction 4: Every correction will correct itself.
After all, it’s in the name.
Though market commentators telling you to rush to gold or cash when the market turns south tend to ignore this simple fact, there has never been a downturn that has not resulted in an upturn. And not only have 100% of bear markets turned into bull markets, 100% of new market highs have gone on to achieve future new highs, as you can see in the chart below. Those are odds we really like.
However, there is no way to predict the timeline for recovery, so we always recommend staying invested as opposed to fleeing to cash. In fact, trying to time the market by jumping in and out is likely to be more harmful than just riding out a downturn. Not only would you have to be right about when to get out and when to get in, you would introduce possible tax consequences. As the saying goes, “It’s not about timing the market. It’s about time IN the market."
Prediction 5: The presidential election will dominate the news, but not your portfolio.
In an election year we may see market volatility in reaction to political news. This is something we expect and are prepared for, particularly since 2016 will also be the first full year in which the Federal Reserve gradually raises overnight interest rates.
(Photo used under public domain)
Remember that history has a long arc, while the news cycle is 24 hours. Reacting to announcements in the news or short-term market movements is counter to a long-term investment strategy.
Prediction 6: You won’t go wrong with regular saving, low costs, diversification, and tax efficiency.
You might be surprised to learn that up to 3% of portfolio performance can have nothing to do with market returns. Unfortunately, most investors impact their returns for the worse by deviating from their long-term plan. According to the 2015 Dalbar study of investor behavior, the average equity mutual fund investor underperformed the S&P 500 by 8.19%, and the average fixed income fund investor underperformed the Barclays Aggregate Bond Index by a margin of 4.81%.
Fortunately, there is a clear-cut way to avoid the behavioral mistakes that contribute to this underperformance. Cut costs, stick to the a properly diversified investment plan, and save regularly.
It’s not an exciting strategy. But it works! Boring can be a beautiful thing when it means greater financial stability for your future. We look forward to seeing this particular prediction come true!