Jason and Emilia discuss stock market volatility and how investors can use planning strategies to help.


Below is the full transcript:


Announcer: Welcome back America to Sound Retirement Radio where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition through retirement. Now, here is your host, Jason Parker.

Jason: America, welcome back to another round of Sound Retirement Radio. So glad to have you tuning in. It is my good fortune to have the wonderful and amazing Emilia back in the studio.

Emilia: Oh, what an introduction. Thank you.

Jason: Well, I missed you so much last week. I had Roger on. He didn’t laugh at the joke.

Emilia: Oh, no. I have a good one for you. I’ve already tested it out so I hope it works.

Jason: Okay. Good. But don’t tell me yet because we got to start the morning right by renewing our mind and we’re going to do that with a verse and this is my friend Steve’s, one of his favorites. He always reminds me of this and we’ve shared it before but it’s a good one. It’s Proverbs 15 and I think it really works into the context of our show today, too. Proverbs 15:22, “Plans fail for lack of counsel, but with many advisors they succeed.”

 Then you’ve got a joke for us.

Emilia: I do. Ready for this one though. I think it’s because I was already laughing about it before. Here it is. What did one eye say to the other?

Jason: I don’t know.

Emilia: Between you and I, something smells.

Jason: I like that. I do like that.

Emilia: I was excited about that one today.

Jason: That’s good. Where did you get that one, Emilia? Where did you find that?

Emilia: I have a little archive of jokes that when I see something, I print it out. I’m like, “Oh, that sounds good.” Then I go through them and I’m like, “Oh, here is one.”

Jason: Oh, that’s a good one.

Emilia: I can’t tell you specifically which site that came from.

Jason: Well, I got to share that one with the kids. They’ll like that one. Thank you. Today, we’re on episode 160, Stock Market Volatility. I thought it was important that we talk about this because we’ve been in for a bit of a wild ride here the last couple of weeks and I don’t want anybody out there to make a mistake when it comes to their retirement money. I have a feeling a lot of people are making mistakes. If they’re not making mistakes, they’re feeling pretty anxious to know that they’re doing the right thing. I think we should talk about that.

Emilia: Absolutely. Why are we talking about stock market volatility though? Is it something specific right now for you?

Jason: Oh, yeah. Oh, yeah. Well, we saw the market dropped over a thousand points in a single day, the single biggest point drop in the market history, not percentage drop, but point drop. Then we’ve just had a lot of this volatility, market is down a thousand points. Then it’s up 600 points and it’s down a thousand points. Then it’s up 200 points. Then it’s down 400 points. It’s just all over the place, Emilia. When the market starts doing this, it starts making people really nervous and I think there was a lot of anxiety out there anyways because we had been through this really unusual period of time where there was almost no volatility in the stock market for the last 14 months or so. People got used to just think the market just always goes up. They got very comfortable being in at risk position.

 I think there’s a lot of people right now that are getting ready to retire or they’ve got retirement on the horizon in maybe the next 12 to 24 months. They’re like, “Man, I don’t want to go through 2008 again and watch this thing drop 30, 40 or 50% right at the time I’m getting ready to retire.” Or, even worse, if they have just retired, they start pulling money out of that portfolio and then it’s going down in value. That’s really a scary situation to be in to be retired and have the market taken at the same time. Very important subject. It’s probably not the right time to be making adjustments after the fact. Planning tries to help make sure that we don’t have to make these adjustments after the fact but still something important that we talk about.

Emilia: Is that like overreacting usually when you-

Jason: Absolutely. Yeah. The market is interesting. There’s so much emotion, so much fear involved. When you see the market drop a thousand points, it does one to two things to people. It either tells them they need to sell and get out and move the cash or they’re the contrary and they say, “Oh, when Monday morning rolls around, I’m going to go out and find some good bargains to buy.” But it’s an emotional decision either way and it’s the wrong way to invest is on emotions because what it says is either you were taking too much risk early or you’ve been sitting on the sidelines waiting for something bad to happen so you can try to capitalize on it. Either way, you’re making an emotional decision about your money. We don’t want that.

Emilia: It sounds kind of scary sometimes. Should people stay invested then?

Jason: Well, that’s a hard question to answer because we don’t know what their planning looks like. I’m reminded that time is the cure to the volatility of the stock market. One of the things we’re always trying to teach is that when you retire, time becomes more important because during your working years, your biggest asset is your ability to earn money and you’re saving money. But once you retire, you lose out on that ability to … You’re not saving anymore. Now what you have is what you have.

 Diversification becomes a two-step process. Let me say that again. Diversification, when you retire or when you’re getting ready to retire, becomes a two-step process. First, you diversify your time horizon based on when you’re going to need the money. Then you diversify within the different financial tools you have available based on the amount of time you have before you need those assets. The key is time. Time is a cure to the volatility of the stock market. The challenge for retirees is time is the one asset they have less of. It’s just understanding what the purpose of it is and also understanding how much time they have.

 An interesting statistic I thought our listeners would enjoy, if we go back to 1937, from 1937 through 2016, the S&P 500 has been negative 19 of those years or 23% of the time. It’s been positive 62 years or 77% of the time. The S&P 500 from 1937 to 2017, negative 23% of the time, positive 77% of the time. If you just think of the market in terms of if you have enough time horizon on your side, there’s a 77% probability that you’re going to end up on the right side of this thing as long as you’re not making mistakes and at the wrong time.

Emilia: Wow that makes a big difference. My next question, Jason, what is the difference between pullback, correct and bear barnket, bear market, correct?

Jason: Yeah, yeah. A pullback, a correction and a bear market real simply because these terms are thrown around all the time, a pullback is when the market drops 5 to 9%, 5 to 9%, and those are pretty frequent, pretty normal. A correction is when we see the market drop 10 to 19%. Again, those are pretty frequent, pretty normal. Then a bear market is when the market drops 20% or more. What we just experienced in the first part of 2018 is the first correction that we’ve seen in a long time. The market dropped a little bit more than 10% from its high and that’s a good thing in my mind because what it tells me is that the market still works.

 See, I was starting to get nervous, Emilia, thinking, boy, with all these quantitative easing and printing of money and government intervention in our economic system that the market wasn’t working anymore. That it was just this financial tool that always goes up. That’s what’s been happening for the last 14 months. It’s so unusual that anybody that’s in this space every day is thinking, “What in the world is going on?” Unfortunately, what that forces or what that causes people to do is it causes them to go take money out of their safe accounts and take more risk with it because they get so comfortable with risk.

 Another interesting statistic that I wanted to share with you is that timing the market is very hard. If you look from 1980 through 2015, the S&P 500 was up on average 12.5%. But if an investor missed out on the 20 best days of the market … The market, again, at 12 and a half percent. If you missed out on the 20 best days of the market, you’re only up 7.2%. If they missed out on the 30 biggest days, their return would be 5.32%. If you play this game where you’re going to try to get in and try to get out, chances of you getting that right are very, very slim and really all you’re doing is hurting yourself and reducing those future returns.

 That’s why most investors, according to a lot of the reports that have been done, miss out on the upward movement of the market because they panic and they sell at the wrong time and they get out and they move the cash. Now, that’s not to say that there isn’t a way or methods for using a tactical component within your portfolio. You just need to understand that you want to use a tactical component within the right time segment of your overall strategy. We’ll talk a little bit more about that in just a couple of minutes.

Emilia: Okay. You mentioned corrections but are corrections something that happen normal or frequently in the stock market?

Jason: Yeah. Another interesting statistic. If we look back from 1900 to 2016, there have been 125 market corrections. That’s nearly one a year. I would say that’s pretty normal to see a market correction at 10% pullback. Now what’s not normal is to see a market that doesn’t have a 10% correction in a year.

Emilia: That’s what we just went through, right?

Jason: That’s what we just went through. I think one of the reasons that this particular correction caught so many people’s attention … Again, we’re nine years in to one of the longest bull markets in the history of the stock market. We see price to earnings of the stock market at levels that historically haven’t been sustainable on the CAPE Ratio that Robert Shiller is always talking about on the television programs at night. Then you see the interest rates rising on the 10 year treasury bonds and people are getting nervous. There’s this old saying that says, “Don’t fight the fed.” For a long time the fed had been slashing rates and trying to pump money into the system. They were pumping money into the system and it was causing all this artificial inflation of these different asset classes. People, they know all of that. They know that that’s the case. It has them stepping on pins and needles. The first sign of volatility shows up and people start moving to cash.

 The other thing is technology spurred some of these because people put these stop-loss orders in and they just have their positions automatically sell when the market hits a certain point and then it just triggers this ongoing snowball effect of selling because the computer step in. There’s a lot of different elements feeding all of these right now. The important thing is that people are thinking about it in the context of their retirement plan. What’s the purpose of the money? What do we need to accomplish? Why did you save it in the first place? Then making sure that you have the right money and the right bucket based on the right time when you’re going to need it.

Emilia: Yeah. I have something to share a little bit because my next question is about going back to the emotions and the bias and it’s just interesting because my husband mentioned that at work when this started to happen everybody got emotional, starts talking about the changes and then they all go and move their money at the same time. That’s that effect where people feed onto each other and that emotional part of it takes over. My-

Jason: People that don’t even follow the stock market.

Emilia: Exactly. That’s what he was saying. They don’t know really what’s going on but they hear somebody say something and they’re like, “Well, that’s what I need to do. I need to get my money out.”

Jason: Then they go into their TSP or their 401(k) and they place trades and they’re not professionals at investing money. They’re just making an emotional response to the news headlines. It’s one of the reasons I turn off the news. I read the business news but I won’t allow the news stations into my house anymore. I just think it’s destructive. It does nothing good to encourage or influence a proper balance in your thinking.

Emilia: My specific question to this was how do people make bad decisions based on the bias and emotions?

Jason: I wanted to share with you a couple of examples that I’ve experienced here just recently. This is an emotional response to the leadership that we have in our country at the time. When President Obama was president, there were people that were absolutely convinced that America was going to go away. That it was just going to absolutely fail because of President Obama’s policies. As a result, some people sat in a large cash position during his entire presidency. During President Obama’s presidency, during those eight years, the stock market was up over 148%. People made an emotional decision because they don’t like the Democrats for whatever the reason. They’re a Republican or Libertarian or Green Party. They don’t like the Democrats. Whatever the reason is. They don’t like President Obama. Then they sit in cash and they miss out on a 148% gain.

 Now the same thing has happened with Donald Trump. There are people out there that don’t like Donald Trump, if they’re a Democrat, or a Libertarian, or Green Party or even people within the Republican party. They make emotional decisions and then they move the cash.

 I’ve actually seen this happen in two ways. I saw in 2008 people were sitting in cash and they missed out on all of the gains of the market because of their emotional belief system, these biases that they have about our political system and now people are doing the same thing. If they like President Trump, they’re investing more heavily in equities, in stocks. If they don’t like him, they’re moving to cash. People make the same mistake over and over and over again and it’s allowing biases and emotions to drive our investment decisions. Anytime we’re making emotional decisions about our money, we need to step back and just take a breather and say, “Are we making a logical decision here?” I just think people need to be careful.

 Now, I think people should feel strongly about their political standpoint. I think that’s one of the great things about America is we’ve got these different parties. We have to battle it out and come to some middle ground. I think that’s good and healthy. But I would be careful about letting those political biases impact your money decisions.

Emilia: Thank you for sharing all that. My next question is what is the difference between strategic and tactical investment management?

Jason: This is important because this is something I wrote about in my book, Sound Retirement Planning. It’s been a couple of years now that the book has been out. Strategic asset allocation, this is a term that I use, strategic. Basically what it’s built on are a couple of different academic theories. One is called modern portfolio theory and the other one is called efficient market hypothesis. Modern portfolio theory won the Nobel Prize in Economics back in 1990 for Harry Markowitz and William Sharpe. Essentially what it says is that the market is efficient. That nobody is going to guess which asset class or sector is going to be the best performer year after year after year and that no one asset class consistently dominates year after year after year. Instead of trying to guess the market, what you do is you create a broadly diversified portfolio across asset classes and sectors and you use low-cost index funds to do this and then you rebalance your portfolios necessary to maintain that asset allocation.

 Strategic asset allocation says you’re fully invested. You’re always invested. You never moved the cash. It works great under most circumstances. But where it fell apart was in 2008 because what happened in 2008 was there were so much fear that entered the market at that point. There was such a strong belief that America would never recover from that financial crisis. That no matter how well diversified you are every asset class except for treasuries was going down in value. You could still have been in a properly diversified portfolio and seeing that the portfolio had dropped 20, 30, 40% even though you were broadly diversified using traditional methods of diversification. That’s what, in my book, I call strategic asset allocation.

 Tactical money management is the exact opposite of that. Nobody has won the Nobel Prize in Economics for it. The other piece to strategic asset allocation, efficient market hypothesis, this is the idea that nobody has access to information faster than anyone else does these days. When you’ve got little black boxes based in the middle of the country that are making split second, millisecond decisions, investment decisions and you think you’re going to be able to turn on the TV at night and watch somebody yelling at their TV screen, hitting buttons and honking horns and you think you’re going to make a good financial decision based on these TV reports, well, that’s just not very … Again, it’s entertaining, but it’s not a good way to manage your investments going into retirement because efficient market hypothesis tells us that all of the information that’s available today is available to everybody instantly. Anybody in the past that had access to information quicker than anybody else, that may at one time had been a strategic advantage but not so much anymore. We all have access to the same information.

 Getting back to tactical. Tactical says, “There are times when it does make sense to move the cash.” But you don’t want to make this an emotional decision. You want it to be mechanical. You want it to be based on computer models and you want the flexibility to be in any asset class. If you need to be in bonds, you’re in bonds. If you’re in commodities, you’re in commodities. If you’re in stocks, you’re in stocks. It’s just that flexibility to move in and out of asset classes based on what’s happening. We would also call that active money management and you have the ability to move the cash.

 The reason that some people like to use a tactical approach to this is because there are times when the market gets way out of whack like in 2008 where being diversified by itself doesn’t really protect you. Having a tactical piece in there that can help you move the cash on some of your money that’s allocated out long term, again time is on your side, that’s the key component.

 Now, the argument that people make there, Emilia, is they say, “Over a long period of time, active money management never beats the index.” It’s absolutely the truth. The logic would tell us we’ll only invest in the index strategy. Only use strategic asset allocation. Never use tactical. But the reality is most retirees aren’t trying to beat the market. What they’re trying to do is beat inflation. What they’re trying to do is not get wiped out in the bad years. That’s why I think it can make sense to combine both a strategic approach and a tactical approach to investing.

Emilia: You’ve just answered a question I had in the back of my mind right there, using both. I have one more question for you then. Why is rebalancing important then?

Jason: Well, rebalancing is important on the strategic side of the equation because rebalancing forces you to be counterintuitive. It forces you to, if you think about this, to sell high and buy low. Before I get too much into this rebalancing, I want to remind our listeners that we do have a webinar coming up. Do you remember what the date is, Emilia?

Emilia: Yes. It’s Thursday, February 22nd at 5:30 p.m. Pacific Standard.

Jason: If you’re getting ready to retire or you’ve recently retired and you just want to understand not only a good investment strategy but also a good retirement planning strategy, how do you diversify across time, we’re going to take people through and show them our exact process that has helped a lot of people and they can make a decision whether or not they think that’s good for them. They can do it from the comfort of their home. They just have to flip on the computer and log in. You can go to soundretirementplanning.com to sign up for that webinar.

Emilia: Great. Just one last time, Thursday, February 22nd at 5:30. Going back to rebalancing.

Jason: Rebalancing. Again, it forces you to be counterintuitive, to sell high and buy low because when you rebalance a portfolio, essentially what you’re doing is you’re saying, “I’m going to sell some of my positions that have done well and I’m going to use the proceeds from that sale to buy some of the positions that have done poorly.” That’s not what most people want to do. What most people want to do is say, “Oh, I have Starbucks stock and it’s doing great. I’m going to hold onto that. My Alaska Airline stock has been tanking the last six months. I’m going to get rid of that,” or whatever, whatever the case may be. That’s what’s most people want to do.

 Rebalancing forces you to do the opposite. Sell positions that have done well. Buy more positions that have done poorly. The idea is there that you’re strategically selling high and buying low. You’ve removed the emotion from the equation completely. What that does is it helps you eventually, Jack Bogle talks about a regression to the mean, eventually one asset class that has done poorly in the past will be the best performer the next year and the best performer will become the worst performer. Now it doesn’t always happen like that where it happens every year. But eventually that’s what ends up happening. When you rebalance a portfolio, it helps you smooth volatility, reduce your risk and earn a fair rate of return over time.

 The challenge with strategic asset allocation is that it’s all based on how these asset classes have performed historically. When you’re doing this risk analysis, you say, “Okay. Well, historically for the last 30 years, bonds have done better than stocks so maybe we should have a higher allocation towards bonds.” The challenge with that thinking, Emilia, is that we’ve also been in the declining interest rate environment for the last 30 years. The fed has been slashing interest rates. Finally, after 30 years, we’re starting to see interest rates go up. Some of that old thinking about how you diversify, having maybe 60% bonds, 40% stocks or vice versa, 60% stock, 40% bond, that traditional method of thinking may not serve you the best going forward so you have to think about what’s about to happen, not what has happened in the past as you’re making these long-term decisions about your money.

 From a retirement standpoint, you have to understand that retirement is all about cash flow. I just can’t say that enough. It is your income that determines your lifestyle in retirement. So many people are worried about the rate of return and the rate of return doesn’t give … Nobody gives a hoot about it. It just doesn’t matter. What matters is your income. See, because you can have a 10% rate of return and that’s great or you can be a negative 10% and that’s bad. But when you run out of money, that’s called going back to work. That’s not called a retirement plan. You better have a good cash flow plan to really understand how this all works.

Emilia: Wow. Do you have anything else that you wanted to focus on as far as the volatility or anything that you wanted to let our listeners know about?

Jason: I just want to encourage our listeners if they haven’t had the opportunity to see one of our webinars to attend this upcoming webinar, understand what a good retirement plan should look like. Don’t make emotional decisions. Don’t allow your emotions and your biases to drive your decision-making process. Create a good plan. Diversify across time. Focus on cash flow. The other piece to a good cash flow plan I always like to plug the retirement budget calculator that we created because so many high net worth people out there have no idea how much money they spend. But if you can just get those elements right, they’re going to have a great retirement. With that Emilia, I realized we’re out of time.

Emilia: All right. Thank you.

Announcer: Information and opinions expressed here are believed to be accurate and complete. For general information only and should not be construed as specific facts legal or financial advice for any individual and does not constitute a solicitation for any securities or insurance products. Please consult with your financial professional before taking action on anything discussed on this program.

 Parker Financial, its representatives, or its affiliates have no liability for investment decisions or other actions taken or made by you based on the information provided in this program. All insurance-related discussions are subject to the claims paying ability of the company. Investing involves risk. Jason Parker is the President of Parker Financial, an independent fee-based wealth management firm located at 9057 Washington Avenue Northwest, Silverdale, Washington. For additional information, call 1-800-514-5046 or visit us online at soundretirementplanning.com.