There are reasons people dig storm shelters in Tornado Alley, build their houses on higher ground on the coast of Florida, and at a basic level why most of us buy insurance. It is to prepare for when things do not go the way we hope or anticipate and to give us a foundation upon which to rebuild in the worst of outcomes. It is human nature that recent history starts to shape our tolerance and expectation of risk. In the case of the equity markets, things have generally been going very well since the down markets during the COVID 19 outbreaks in 2020. Since then, the equity markets have had outstanding returns, giving most of us a feeling of financial strength and security. But it is the emotional “feeling” that is often the downfall for many of us.
Fear and greed drive too many of our financial decisions. It is wired into our evolutionary DNA. When we feel wealthy and financially stable, we are more apt to take risks. In the financial markets that means we buy riskier stocks with larger perceived return potential. We tend to position more of our portfolios to the riskier side of our allocation because we “feel” more secure and recent market behavior has made us “feel” that we can tolerate more potential volatility.
Historically, we can look at how this eventually runs its course for most investors. At some point over the horizon a financial storm will start to build. Most of us will not see it coming and even if we do, we often have become so comfortable in the recent success of the markets that we ignore the signs and fail to prepare for its impact. When the market turns there’s a tendency for denial that lasts for too long as portfolio values decline. We convince ourselves that it is temporary and the market will rebound shortly. When some investors finally panic and sell, they may make another bad financial decision and sell riskier assets at the bottom of the cycle. At this exact moment, rare people like Warren Buffet start to buy heavily. Often, investors then over allocate remaining investments into lower risk assets, like investment grade bonds at the moment when the masses are doing the same thing, and those assets are often priced at market cycle peaks. In summary, we let our emotions drive the ship and we “sell low” and “buy high.” Exactly the opposite of what we are supposed to do.
What if we prepare for the storm? What if we acknowledge that it is a perfectly normal part of a financial cycle to have periods of growth and periods of contraction that are often caused, especially on the contraction side, by unforeseen events? What if we can create enough stability of principal and income that we are less likely to panic in the depths of the next downturn because we are confident in our ability to comfortably ride out the storm and wait for the right moment to buy at the bottom of the risk market cycle with confidence instead of selling in panic?
Most of us working in the fixed income department of Raymond James have been doing this for quite a while. It takes decades of history to have experienced, not just read about, the emotional toll a market storm can take on investors. We have seen the cycle many times before. When confidence in the markets is high and risks “feel” less risky, that is when you need to prepare. Imagine guarding against the next financial storm by having a portfolio of investment grade bonds, positioned around your unique objectives, that will perform regardless of interest rate moves. Imagine having the confidence of knowing you have the financial stability to ride it out and make decisions based on the opportunities and not the panic that inevitably drives the bottom of the cycle. We may not know when the next financial storm will hit but we do know that it “feels” like it is time to prepare.
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