Investing is all about managing risk, and one of the biggest risks we face is our reaction to the latest news, financial and otherwise. This month, Peter and Jonathan look ahead to possible developments in 2024 and the risks they pose. Plus, how much you should have in bonds when you receive other regular income and why you should ask your children ahead of time what “stuff” they’d like to inherit.
Hosted by Creative Planning Director of Financial Education, Jonathan Clements, and President, Peter Mallouk, this podcast takes a closer look into topics that affect investors. Included are in-depth discussions on financial planning issues, the economy and the markets. Plus, you won’t want to miss each of their monthly tips!
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Jonathan Clements: This is Jonathan Clements, Director of Financial Education for Creative Planning. With me is Peter Mallouk, President of the firm, and we are Down the Middle. Investing is all about managing risk. And one of the biggest risks we face is our reaction to the latest news, financial and otherwise. With that in mind, today Peter and I are going to look ahead to possible developments in 2024 and the behavioral risks that they pose. For instance, the S&P 500 last hit an all-time high on January 3, 2022. Here we are almost two years later and many investors are antsy about their portfolio’s performance. Peter, if the current stock market rally continues into 2024, isn’t there some risk that investors will start bailing out of stocks because they’ve recouped their losses, they feel like they’re back to even, and they don’t want to risk getting caught in another stock market downturn?
Peter Mallouk: There’s two kinds of investors. There’s one kind of investor that holds their stocks because they want to wait until they break even. And then when they’re there, they’re feeling good because they’re on quite the run. And so they hold them while they continue to go up. It’s like the player at a blackjack table. “I’m only going to play ‘til I break even.” But by the time you get there, you’re feeling good, so you keep going, except it’s the reverse with the stock market. It’s good that you stay in the game, because the longer you’re in the game, you win. I do think there’s a small group that will probably bail out, but I think it’s very, very small.
Usually, the group that’s going to bail out is the group that already has. They tend to bail at the worst times when the markets are at their worst, consumer sentiment is at its worst. And a lot of those people, that happened about a year ago. I mean, you’re right. We’ve got two years of zero, two years of zero. This year looks great, but it doesn’t even yet offset where we were. If you look over long periods of time, when you have a period of time like this, the expected rate of return of the stock market going forward three years is actually in the double digits. It’s higher than normal, so investors should be optimistic if history is any guide. That doesn’t mean optimistic about next year, but certainly over a rolling three-year period.
Jonathan: Yeah. I mean, if your basic MO in the stock market is to get even and then get out, you’ll never be there for the great long run returns. If you’re not in the market for at least five years, and preferably 10, 20, 30 years, you’re simply not going to enjoy those long returns that come with stock market compounding that could really create enormous wealth. But we have to say, this sort of loss aversion, this desire to avoid future losses to sell when we get back to even, it’s pretty classic investor behavior.
Peter: Obviously, the people that have the most money is the boomer generation. They’re the ones that have the peak wealth. And look at what they’ve been through, the tech bubble and 9/11. So you had this sudden massive drop, very fear-based. You had ’08, ’09, massive drop that went on for years and years and years with a ton of uncertainty and volatility. COVID, fastest 34% drop in history. And then you have a lot of periods like the last two years, 24 months of zero. And so the market is going to hit you. It’s never going to give you the same punch. It’s always a different punch. But about 25% of years you’re going to get punched. It just never comes in the same direction. And if you can just stay through all of it, to your point, Jonathan, you’re going to get those expected long-term rates of return, which our clients have gotten that have stayed in the game and stayed invested, and in fact, maybe even gone in a little bit more during those worst of times. But you’ve got to take the punches to come out on the other side.
Jonathan: So talking of punches, we’re going to see some political punches thrown in 2024. We’ve got a presidential election coming up. And Peter, we’ve talked about this before, people sought to invest based on their political preferences. And I can imagine a situation in 2024, if you’re a Democrat or if you’re a Republican and your favorite presidential candidate looks like they’re going to lose, there’s a risk you’re going to bail out of the stock market because you fear the consequences. I mean, right? We’ve seen this before, haven’t we, Peter?
Peter: Yeah. Trump, Obama, probably the two times in my career where I saw the most depression from different groups of people, obviously, and this fear that everything was going to fall apart. And in both cases, that’s not what happened at all. With Obama, we saw the turnaround from ’08, ’09. And with Trump, we saw it was the first time in history or one of the first times in history the stock market went up 12 months in a row. In both cases, no matter how you felt about politics, the market did just fine. The market just does not care about this that much, it just doesn’t.
Jonathan: So we’ve had lackluster stock and bond market returns for the past couple of years, the one place where people have really had a good time is sitting in cash investments, sitting in money market funds, certificates or deposit Treasury bills thanks to the Federal Reserve and the raising of short-term interest rates. The yields on these investments have been handsome for the first time really in decades. But of course, something bad may well happen in 2024, which is, if the Federal Reserve starts cutting short-term interest rates, those handsome cash yields are going to disappear. And for people who’ve been sitting in cash investments thinking they’re smart to stay out of the stock and bond market, it’s going to be a huge dilemma, Peter. Aren’t we going to see a lot of regret and a lot of people pacing on the sidelines wondering what to do?
Peter: I think it’s a big mistake to get excited about cash. I mean, while cash yields are certainly better than they’ve been for the last 10 years, when they were close to zero, they’re still in the very low single digits on an after-tax basis, and you can’t lock in anything. They’re also barely keeping pace, if not lagging inflation. If you want to stay out of inflation over the long run, stocks are the way to go. If you have to touch something real, then real estate is another choice. And if you want to lock in some of this return, you can buy bonds as well that are a little bit longer-term. Not cash, but some things that go out a little bit. But we’re still almost certainly going to underperform stocks. Also, I think this idea is that cash is a place to go and then you get back in the water when things are better. But by the time things are better, it’s too late. The market will have gotten away from you, and we might have already seen that this year.
Jonathan: So our final behavioral mistake that we’re going to tackle in this podcast, both U.S. and international stocks lost market in ’22, but at least foreign stocks held up relatively better. But this year, we’re back to what’s lately been business as usual. We have U.S. stocks once again handling outpacing foreign shares as they have in most of the past dozen years. My big fear is the investors are going to start banning their international holdings, and I think it’ll be a huge mistake. Where do you stand on this one, Peter?
Peter: I think whether you look at foreign stocks or small cap stocks, I mean, these have really tried investors’ patience. The disadvantage of a diversified portfolio is something’s always underperforming, and international stocks is one of those categories. And this hasn’t gone on for a year or two, it’s gone on for 13 years. And at the turn of this most recent decade, we saw Goldman and JP Morgan and BlackRock and Vanguard all agree on something. They never agree on anything, and they all agreed international would outperform the United States and small cap would outperform large cap, but that hasn’t happened so far. Now, those of us that are nerds and study the market over the very long run, we know that, when the gap closes, it closes so quickly. It can erase years and years and years of a discrepancy in weeks or months.
That day will come and no one ever knows when it is. It’s the price to pay for being a diversified investor. There will be a period where large cap underperforms. We had the same conversation in reverse as advisors about 10 years ago. When we went through 2000, 2010, there was only one major asset class that earned zero, and it was large cap U.S. stocks. It had gotten destroyed performance-wise by international, which did much better, emerging markets, which did better, small cap, which did better. And you had to tell people, “Hey, wait it out. Eventually, large cap will have its day.” Well, it’s had its decade, right? And so yes, obviously, just like we stuck with U.S. stocks and they turned around, wise investors should stick with other asset classes and they will eventually have their day back in the sun as well.
Jonathan: All right, Peter, so it’s that time of the podcast, time for your financial wellness tip of the month. What have you got for me this month?
Peter: So when people are building portfolios, you tend to think about owner, lender, stock, bond. And obviously, there’s more to it than that, real estate alternatives and so on. But generally, let’s just keep it basic. You’ve got stocks and bonds. And the question becomes how much should you have in bonds given if you happen to have other investments? So we have a lot of clients that have pensions, they have a fixed annuity that pays them a certain amount, or they have a rental property that pays them a certain amount. In an instance like that where you’ve got income and it’s either guaranteed or close to guaranteed, you should look at that as bond-like. It’s a fixed income source coming into the household, particularly if it’s a fixed annuity or a pension. And that should give you the comfort to reduce your bond allocation, which ensures you’re still secure because you’ve got fixed income coming with the bonds, but still allows you to probably perform much better over the long run. So a lot of people ignore their non-liquid investments, and they very much should be part of their portfolio allocation. How about you, Jonathan?
Jonathan: So Peter, this month I have a tip based on a lot of comments I’ve got from readers of my site, and I get this from family members as well. And it’s this. If you have adult children, ask them which of your possessions they’d like to inherit. Your kids may want to inherit your money, but there’s a good chance they want little or nothing of your stuff. Find out what they want and don’t want and give away the stuff that they don’t want or tell your kids they should feel free to dispose of them after your death so that your stuff doesn’t end up being a burden to them.
Peter: Well, we just went through this. We lost my wife’s mom and dad both in the last 12 months, and they lived in our neighborhood. We were taking care of all these items. And estate plans are very clear about the money gets divided this way. It’s very clean. Personal property is where all the emotion is. And it’s not just the emotion that people sometimes talk about, like everyone might want the same jewelry or whatever. It’s exactly what you just said, which I never had thought about. Even though I am an estate attorney and financial advisor, it’s the guilt that comes with, hey, I don’t want this, but I feel like maybe one of my siblings should want it. Now nobody wants it. I feel bad giving it away or donating it or selling it.
That’s really good advice to not just talk about, hey, these are special items that I want you all to specifically get, and you guys tell me what else is important to you. But also the conversation of, hey, it’s okay. And when I had that conversation with my kids, two of them are still teenagers, the day we were in the house cleaning things out, I just said, “Hey, I want you to know there are two or three things that I think I would love if you kept. The rest, you keep what you want. But everything else, don’t feel bad for a second donating it or selling it.” And so very, very good advice. Great tip to end the podcast with, Jonathan.
Jonathan: Yeah. And just remember that, if you don’t tell your kids, they may assume it has an importance that it doesn’t even have to you. I have certain possessions that, when I’ve talked to my mother about them, she gave them to me. I was like, “I don’t want to give it away because you gave it to me. And my mother’s like, “I did. When was that?” It’s far less important in her head than it was to me, and that freed me up to get rid of the stuff.
Jonathan: So anyway, Peter, that’s it for this month. This is Jonathan Clements, Director of Financial Education for Creative Planning. I’ve been talking to Peter Mallouk, the President of the firm, and we are Down the Middle.
Disclosure: This show is designed to be informational in nature and does not constitute investment advice. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment or investment strategy, including those discussed on this show, will be profitable or equal any historical performance levels.