Reducing Stock Exposure - What is the Worst That Can Happen?
Disciplined investing is not an unwavering commitment to a buy-and-hold strategy. I believe the discipline to focus on achieving goals may require temporarily abandoning a plan that serves as a guideline but is not etched in stone. Markets have historically risen, with the U.S. market producing positive returns in 75 of the last 99 years¹. Due to its long-term upward consistency, it is widely regarded as a prudent financial move to stay invested in the market. The risk of being out of the stock market is not an actual loss but rather an opportunity cost of missing out permanently on potential higher market returns once the market recovers; evidence has shown that it always recovers, but we don’t know when.
¹Source: Center for Research on Security Prices, Chicago, IL. CRSP 1-10 index measures the performance of the total U.S. stock market, which it defines as the aggregate capitalization of all securities listed on the NYSE, AMEX, and NASDAQ exchanges.
My investment philosophy has remained unchanged for 25 years – “letting the markets work for us instead of against us.” The longer the period, the greater the potential for favorable investment returns since investors with longer investment time horizons are more likely to withstand short-term market volatility. However, the unprecedented unilateral tariff actions have somewhat modified my long-standing philosophy, which has centered around the trust in market efficiency – current values reflect all known information and expectations, and no one individual knows more than the collective market. I believe that efficiency does not satisfactorily exist at this time.
Because of the items listed below, reducing exposure to the riskier asset classes (at least until efficiency returns) should be considered:
1) Rates on short-term cash and cash equivalent investments such as CDs (one to twelve months), Money Market funds, and short-term Treasuries yield above 4.0%, which exceeds inflation. According to the Consumer Price Index, the twelve-month inflation rate as of February 28, 2024, was 2.8%. During the “Great Recession,” which lasted four consecutive quarters from the third quarter of 2008 through the second quarter of 2009, the rate on a six-month CD had fallen to 0.87 percent. Today’s higher cash rates make the risk of missing out on potentially higher stock returns less of a reason to remain heavily invested in an unprecedentedly uncertain market.
2) Exposure to riskier investments should decrease as time horizons grow shorter. A sixty-year-old's investment time horizon is longer and, therefore, able to weather short-term market declines than that of a seventy-five-year-old, who is focused more on preservation; their investment strategy should reflect that. The market has produced positive returns 75% of the time since 1926. Still, consecutive years of losses can dramatically impact planned goals for retirees with shorter investment time horizons.
3) In the short term, the downside of a prolonged trade war and a probable recession is far greater than the upside of the global economy getting back on track. If all the tariffs were to disappear tomorrow, the market would undoubtedly respond favorably, but the seeds of a different type of market risk have been planted across the globe. The U.S. market has been a symbol of efficiency and trust, free of the political risks many emerging countries face. The U.S. has the largest economy in the world, and our dollar is considered the world's reserve currency, so the current situation qualifies for extreme uncertainty, as any semblance of “efficiency” has been temporarily disabled.
Watch Out For Taxes!
For qualified tax-deferred accounts such as Traditional IRAs, there is no tax liability on a security sale, but for taxable accounts, either ordinary income or capital gain tax will apply. The US market performed well in 2023 and 2024, so unrealized gains may exist (See IRS Publication 550 – Sale of Assets). The cost basis of each investment to determine your potential should be available through your brokerage.
Stop/Limit Orders
Let’s say you own a security XYZ, and the price of one share has fallen from $150 to $120 per share. You still want to hold on to the stock since you feel it will eventually recover its losses and experience positive growth, but you do not want the share price to fall below $100 because you are in retirement, and the recovery may take longer than you expect. A stop order can reduce further risk and trigger the stock sale at $100. Please see https://www.schwab.com/learn/story/3-order-types-market-limit-and-stop-orders.
When to Increase Exposure Again?
The attempt to time the market usually is not an effective strategy because it requires two correct decisions – when to get out of the market and when to get back in. It is already difficult enough to forecast one of those decisions. However, the fact that the beginning of this economic turmoil was triggered by the actions of the President, and not the “free-trade” happenings of the markets, the remedy then will have him be the catalyst of a recovery, or at least some level of calm in the markets. Can the markets regain the confidence and the efficiency of rewarding investors for their risk tolerance?
Navigating through these strange and unprecedented times will require reliable sources of information, expertise, and fiduciary duty by those hired to help you. My company can provide the guidance needed to keep you focused on your goals while choosing optimal investment and planning strategies to help you reach your financial objectives. Please call us at (925) 484-1671 or email us to schedule a no-charge consultation and portfolio review.
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.
