At Winthrop Wealth, we follow a Total Net Worth Approach to wealth management that combines both comprehensive financial planning and investment management. The financial plan helps define cash flow needs, seeks to optimize account structures, considers tax mitigation strategies, and determines the appropriate asset allocation based on the client’s willingness and ability to take risk. Based on the output of the financial plan, our investment management process designs a well-diversified portfolio constructed with a long-term methodology based on prudent risk management, asset allocation, and security selection. Financial planning is a tool intended to review your current financial situation, investment objectives and goals, and suggest potential planning ideas and concepts that may be of benefit. Please note that there is no guarantee that financial planning will help you reach your goals.

As a wealth management firm, we strive to keep our clients on the course outlined by their financial plans by focusing on the long-term.  Market volatility is inevitable, and therefore we advise against getting caught up in short-term noise.  There is seemingly always an “expert” in the media spouting their opinion on why markets will crash.  Unfortunately, we see more fearmongering than sensible analysis in mainstream financial news.  As such, the principles for long-term investing and why market timing does not work are frequently discussed topics.   

Market timing is an investment strategy that is implemented by selling a large portion of equity holdings when the market is high (keep in mind this could result in substantial capital gains for taxable investors), patiently waiting on the sideline as the market declines, reinvesting at the market low, and then riding the market back up to new highs. Rinse and repeat. Although this might sound easy, the reality is that successful market timing is nearly impossible to execute consistently. Market tops and bottoms are never obvious in real time, only in hindsight. To execute a market timing strategy an investor must get two decisions precisely correct: when to sell out of the market and when to buy back in.  Most investors come up short with the second decision, buying back in.  We will note that if an investor discovered the magic formula to market timing, they would essentially be able to make an unlimited amount of money. There is no magic formula.  

Market timing decisions are often short-term emotional decisions driven by fear or panic rather than fact-based analysis.  Given the damaging impact that market timing decisions have on performance, our investment process emphasizes a long-term mindset.  Markets have historically increased over time despite frequent drawdowns as successful corporations have been able to figure out ways to generate profits through advances in innovation and productivity. To capitalize on the power of compounding, we believe in the benefits of staying Disciplined, Opportunistic, and Diversified, while striving to Mitigate fees, taxes, and expenses. 

• Disciplined: consistently applying our investment process and philosophy, which are grounded in a long-term approach. 

• Opportunistic: rebalancing, repositioning, and tax-loss harvesting to take advantage of market volatility and dislocations. 

• Diversified: seeking to ensure that portfolios are properly allocated across and among asset classes to enhance consistency. 

• Mitigate: striving to avoid unnecessary disbursements, including fees, taxes, and expenses. 

In our opinion, adhering to a structured process and executing on all these components should help keep our clients on track toward pursuing their long-term objectives. Historically, equity markets have recovered from recessions and downturns. Past performance is no guarantee of future returns. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. 

The stock market has gone up over time

From 1928 to 2023, the stock market produced a total annualized return of +9.6%.  A $1 investment in 1928 would have increased to over $6,400 at the end of 2023.

We would also like to highlight that this period includes several of the most challenging market environments in history, including, the Great Depression, World War II, 1970’s Stagflation, Crash of 1987, Dot-Com Bubble, Global Financial Crisis, Covid Pandemic, and 2022’s inflation and Fed tightening.  The total period includes thirteen bear markets, fifteen recessions, and dozens of corrections and pullbacks.

When you buy a share of stock, you are purchasing an ownership stake in the underlying company, which represents a claim on the firm’s cash flows, earnings (profits), and dividends.  Stock prices reflect the present value of the company’s expected future earnings.  Markets have historically increased over time as successful corporations have been able to figure out ways to generate profits through advances in innovation and productivity.  Equity markets have historically recovered from recessions and downturns.  Past performance is no guarantee of future returns.  Consider your own risk tolerance, financial circumstances, and time horizon when investing.

The stock market has gone up over time, but returns were not linear

Since 1928, the stock market produced positive results in 70 calendar years vs. 26 years with negative returns.

The market went higher in 73% of years with an average return of +21% and declined in 27% of years with an average drop of -14%.

Market declines are common

One of the key pillars to our investment philosophy is to maintain a long-term viewpoint as markets can be incredibly volatile over short time periods. During inevitable market declines, while they can certainly be uncomfortable, we utilize the volatility as an opportunity to make lemonade out of lemons by proactively tax-loss harvesting and repositioning portfolios.

The following chart displays the average annual and total number of occurrences of various market declines in the S&P 500 from 1928 – 2023. For example, the S&P 500 has averaged over seven -3% dips and about one -10% Correction each year, and a Bear Market every 0.14 years (about one every seven years).Intra-year declines are common

The following chart displays the S&P 500’s annual return and the largest intra-year decline from 1980 through 2023.

Over this period, the S&P 500 has generated a total annualized return of +11.8%.  Annual returns ranged from -37.0% to +37.6%.

There were plenty of market drops along the way as the average intra-year price decline was -14%.  Note that in 17 instances, the market finished in positive territory for the year despite a decline of at least -10% at some point. 

Bear markets happen

A bear market is defined as a decline of -20% on a closing basis without a subsequent +20% increase.

Since 1929, the S&P 500 has experienced 13 bear markets (about one every seven years).  During these periods, the S&P 500 took about 17 months to reach the bottom with a median price decline of -34%.

Historically, bear markets have created strong buying opportunities as the S&P was significantly higher 1-, 3-, and 5- years after the trough.

Beware of Dire Market Predictions

As a wealth management firm, we are inundated with a never-ending flow of predictions about what is going to happen in the markets.  We also understand that our clients are not isolated from the constant barrage of news, noise, and prognostications as we often have conversations with our clients regarding a so-called expert’s prediction on an upcoming market crash.  Like a broken clock, these doomsdayers are “right” every now and then when volatility increases and markets sell-off.

One of our favorite research pieces is called “The Armageddonists” from JP Morgan Asset Management.  Armageddonists are defined as the “market-watchers, forecasters, and money managers whose apocalyptic comments spread like wildfire in print and online financial news.”  JP Morgan published the original report with several failed bearish predictions over the period 2010 – 2016.  The most recent iteration includes eight dire predictions from notable market commentators during the beginning stages of the Global Pandemic.

The following chart shows the performance of the S&P 500 from 2020 through 2023, and it highlights the date of each gloom-and-doom prediction.  We know how this played out.  The world did not end during the pandemic and after declining over a 6-week period from February to March 2020, markets began to recover significantly.  Since the bottom on March 23, 2020, the S&P 500 has increased by over +125%.  Anyone who acted on the bearish advice by selling their equities and retreating to cash likely would have missed out on the subsequent rally, and a taxable investor potentially would have generated a large capital gains tax bill in the process.

There are always “reasons to sell”

The following table displays S&P 500 annual returns from 1973 to 2023 and the top risk or reason why an investor could have been frightened out of the market each year.

An old investment adage is that the stock market climbs a “wall of worry.” This simply means that the market has risen over time despite a constant barrage of potential risks that could cause a correction or decline.  The market always has risks to overcome and there is never an “all-clear” signal.

The 24-hour news cycle and advent of social media might make it seem as though risks are more prevalent today, but they have always existed. Historically, you might not have found out about economic data or company specific news until you read about it in the newspaper the next day. Now, everything happens in real-time with a never-ending flow of pundits and articles ready to pontificate about what happened and how it may impact the markets.

We caution our clients not to overreact to one data-point, piece of news, or what a so-called market authority might be predicting.

Missing the best days crushes investor returns

Investors who wait on the sidelines for the “optimal” time to buy often miss significant rallies.

A $1 investment in 1980 would have increased to about $135 at the end of 2023.  Note, this period includes over 11,000 trading days and assumes the individual stayed fully invested.  If an investor missed only the 10 best days in the market, their total return would have been less than half.  If an investor missed the 40 best days, their return would have been about one tenth.  All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

To make things more difficult for market timers, the best days have historically occurred during periods of severe market stress.  Nine of the ten best days in the market over the last forty-four years occurred during either the Global Financial Crisis (2008-2009) or the Covid Pandemic (2020).  Nervous or frustrated investors who threw in the towel would have missed the subsequent market rebound and devastated their portfolios.

During periods of market stress, it is impossible to know when the market bounce will occur, but we do know that missing the bounce has historically had a severe negative impact on total return.

The average investor underperforms due to market timing

The following chart is from a Dalbar study titled “Quantitative Analysis of Investor Behavior” that displays the annualized returns of various asset classes and the average investor for the thirty-year period of 1994 through 2023.

The average asset allocation investor’s return is based on an analysis of the net aggregate mutual fund sales, redemptions, and exchanges each month.  The study shows that the average investor’s return over this period was less than half of stocks and lower than bonds.

Dalbar cites market timing as a main factor for poor investor performance.

DALBAR’S 2024 Quantitative Analysis of Investor Behavior (QAIB) study examines real investor returns from equity, fixed income and money market mutual funds from January 1994 through December 2023. The study was originally conducted by DALBAR, Inc. in 1994 and was the first to investigate how mutual fund investors’ behavior affects the returns they actually earn.  https://www.dalbar.com/QAIB/Index

The benefit of diversification

Diversification and time are an investor’s two best friends. Diversified portfolios can lead to more consistent and less volatile results than a single asset class. We know that markets can be extremely volatile in the short-term, but difficult periods have historically not lasted forever.  Asset allocation does not ensure a profit or protect against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio.

To highlight the benefits of diversification, we examined the total return performance of nine separate asset classes and a diversified asset allocation from 2008 to 2023 (see below for the asset class index key and weights of the diversified allocation).  Notice that from year-to-year many asset classes rotate from top to bottom performers. We will also highlight that the asset allocation has stayed consistently in the middle.

The value of time

The following chart displays the historical high, low, and average performance of various stock and bond benchmarks over rolling periods from 1976 to 2023.

As the rolling time-period increases, the range of outcomes narrows as the highs and lows become less extreme.  Our key takeaway from this chart is that the longer the time-period, the greater historical likelihood of generating a positive return.  Over the short-term, markets can be extremely volatile with severe drawdowns occurring suddenly.  Over the long-term, markets have historically increased and rewarded those who stayed invested.  Past performance is no guarantee of future returns.  Consider your own risk tolerance, financial circumstances, and time horizon when investing.

The power of compounding

Compound growth refers to the return on an initial amount of money (principal), as well as on any accumulated earnings (interest, dividends, and/or price appreciation). The power of compounding, which becomes more noticeable over time, is the ability to add accumulated earnings onto the initial principal each period.  Although compounding offers the potential for substantial growth over long periods, it requires consistency and discipline.  All investing involves risk. No strategy guarantees success.

To better illustrate this concept, the graph below showcases the historical growth of $1 invested in various indices from 1976 to 2023.  Although these indices have different risk-return profiles, all have shown the historical ability to compound returns over long periods.  All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

Withdrawing Money

One of the most common and costly mistakes an investor can make is to not plan for a scheduled cash flow need in advance, and then fund it by selling equities AFTER a significant market decline. A major component of our Total Net Worth Approach to comprehensive financial planning and investment management is to identify and account for upcoming cash flow needs. We often invest at least two to three years of scheduled cash flows in conservative ultra-short fixed income to decrease the likelihood that we will need to sell out of risk assets after a market decline to fund distributions.

The following graphic is helpful to understand our approach to funding distributions. The chart displays both the Rolling 12-Month Percentage Return and Total Return from 1976 through 2023 of a benchmark comprised 60% S&P 500 and 40% Bloomberg Aggregate Bond Index. The Rolling 12-Month Percentage Return portion shows that returns can vary significantly over annual periods. When equity markets are strong, we frequently fund distributions from equity holdings, which means we are trimming stocks into strength. When equity markets are weak, we often fund distributions from the more conservative fixed income holdings. All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.

Investing New Money

Since the investor’s worst nightmare is to invest new money right before a significant market decline, we decided to examine both the short and long-term impacts of this scenario.

The following chart displays the performance of the S&P 500 during the last ten bear markets going back to 1950.  In our two scenarios, the investor puts money to work at a “terrible” time, either 30- or 90-days before the eventual bear market bottom.

This study illustrates that time invested in the market matters more than investing at the perfect time.  In investing, perfect can be the enemy of good.  While it would be nice to make the perfect investment at THE market bottom, if you believe the current environment is at least a good time to invest, then we suggest putting a portion of your capital to work.  No one knows when the ultimate market bottom will occur since it can only be identified in hindsight (although this will not stop the pundits from guessing).  Historically, equity markets have recovered from recessions and downturns; however, past performance is no guarantee of future returns.  Consider your own risk tolerance, financial circumstances, and time horizon when investing.

At Winthrop Wealth, we work closely with our clients to execute a transparent plan to invest new money.  In our opinion, the best way put new money to work is to agree to an investing schedule with some flexibility that makes the client feel confident in the process.  Rather than attempting to wait for the perfect time to buy, our approach allows us to make a series of buys and to save some dry powder as new opportunities arise.  This increases the chances that some of our buys may be at good to great prices.  In our opinion, our methodical approach is far more effective than trying to find the perfect time to invest everything at once.  No strategy assures success and all investing involves risk, including loss of principle.

Investing After Market Declines

The following chart utilizes S&P 500 month-end data from 1928 – 2023 and shows the subsequent 1-, 3-, and 5-Year total return when the initial investment occurs when the index price is down more than -10% from the all-time high.  Historically investing after market declines has produced both strong average annualized returns and a high percentage of positive outcomes.

During difficult market periods, we believe those who were able to either stay invested, rebalance, or add to their existing holdings will eventually be rewarded.  Historically, equity markets have recovered from recessions and downturns.  Past performance is no guarantee of future returns.  Consider your own risk tolerance, financial circumstances, and time horizon.