I think I’ve mentioned this before, but the news media drives me crazy. After almost 2 years of wonderful market returns, everyone seems to be losing their minds because we have seen an increase in volatility recently. You may have trouble believing it, but this type of volatility is more common than anyone else is telling you. Since 1980, the S&P 500 usually drops an average of 14% almost every year, despite ending positive over 75% of those years.[1]
This further emphasizes my belief that we are living in a world that thrives on fear. In the Bible we find God encouraging us to know that, “God has not given us a spirit of fear, but of power and of love and of a sound mind.”[2] I thought I would take some time today and share a story about my grandmother that demonstrates a way of thinking that I believe we’ve lost in today’s culture.
My grandmother was born in the heart of the depression. Both she and my grandfather kept fruit trees and a garden in their backyard. Many of my memories involved spending time from Springtime to Fall picking fruit fresh off the trees and harvesting fresh picked vegetables for an evening meal or salad. I can’t remember anything tasting better.
As a product of the depression, my grandmother never wasted anything. Because of this, many of my childhood memories also involve marathon sessions of watching my grandmother, aunts and mother canning those extra fruits and vegetables. I remember the mason jars used for canning; I remember the steam and pressure cooker that would seal out all the air for preservation. I remember taking those jars down to my grandmother’s dirt cellar and lining them up on shelf after shelf.
I remember once asking my grandmother why she spent so much time canning. Here was her response.
“Some of those jars are for us to eat through the winter. There is a season for everything, but during the winter we wouldn’t have anything to eat if we didn’t put some away for later. Some of those jars are for the years when we don’t harvest as much or the years when we don’t have any harvest.”
“Not every year is as fruitful as this year. There are years when the insects swarm and eat everything before it can produce. There are years when the sky dries up and we don’t have moisture to grow enough food. We know that most seasons produce a good harvest, but not every season is bountiful. We spend time canning so that if we have a year when the produce is lacking, we will still have food to eat.”
You may be wondering why this story seems so relevant today? It is relevant because it makes me think of investing. I know you think I’ve lost my mind, but if you will be patient, I think you will find that my grandmother knew more about investing than anyone on Wall Street.
Just like most of the harvest years are positive, most stock investing years are positive. As I mentioned above, since 1980 over 75% of annual returns in the S&P 500 are positive.[3] Just like harvest years, predicting whether the next year’s returns in stocks will be positive is next to impossible. However, I think we can use the same principles my grandmother used to look at investing in a different light.
Fundamentally, the reason we own stocks rather than any other asset class is that over the long term they have shown the ability to substantially outperform bonds and inflation.[4] In a world of rising costs, I want to own things that can help me keep up with those increasing expenses. However, it would only be fair to acknowledge that stocks come with far more volatility than most other investments. For example, although large company stocks have averaged a 10% return over the last 80 years there have been years when that investment has been up over 75% and years when it has lost over 50%. The “average” looks great, but the journey to get there is quite bumpy.[5]
My grandmother had a Farmer’s Almanac that helped her to understand the best times to plant and the best times to harvest. This almanac, however, was not predictive of what would happen. It gave its best guess based on history. For us, the same is true. There are two pieces of history that we can reflect on that will help us understand the past, not so that we can predict the future, but so that we have a guide. On average when we experience a bear market (a drop of 20% or more) it takes 40 months for stocks to get back to even (that’s a little over 3 years).[6] It is also worth noting that since 1950, 97% of 5 year rolling returns for the S&P 500 have been positive.[7]
With this knowledge, there are two pieces of information every investor must know. “How much will I need to withdraw from my portfolio for the next 12 months?” as well as,”How much will I need to withdraw over the next five years?”[8] If you don’t need any of your money for withdrawal over the next five years, our investor’s “almanac” would indicate you should probably have most of your investments allocated to stocks.
However, if you are living off your portfolio or need to take withdrawals within the next five years, I think you will find that my grandmother was a great investor. My grandmother always had enough jars canned so that her family would have enough to eat for the next year. Similarly, you should have one year’s worth of withdrawals in cash.
The remaining 4 years are a great lesson in my grandmother’s wisdom. You should keep the remaining 4 years’ worth of withdrawals in something more liquid like bonds or CDs. If the next year produces a harvest, then use the excess to build another year of cash to enhance your 5-year cushion.
However, what do you do when the markets decline substantially? (And trust me, they will.) While everyone else is panicking, you look at your bond account and say, “Just like grandmother knew there would be a season without harvest, I knew this could happen to my investments. I’ll sell off some of my bonds to live on and wait until the harvest returns.” In this example, you’ve given yourself a 5-year cushion in which you can wait. Will it work perfectly? I don’t know. However, based on our “almanac”, it puts the odds in our favor based on average recovery time and 5 year rolling returns. As the years improve, you begin to use the new harvest to build back up to a 5-year cushion.
This gives us a plan that even my grandmother, and probably yours, would approve of. And, as the media goes crazy over things that are completely out of our control, remember that fear is a waste of energy. Grandmother’s wisdom demonstrates more power, love and a sound mind than any of the talking heads in the media today.
[1] “Annual Returns and intra-year declines”, JP Morgan Asset Management Guide to the Markets, Page 13, March 31, 2018
[2] 2 Timothy 1:7, New King James Version®, Copyright©1982 by Thomas Nelson. Used by permission. All rights reserved
[3] “Annual Returns and intra-year declines”, JP Morgan Asset Management Guide to the Markets, Page 13, March 31, 2018
[4] Ibbotson SBBI (Stocks, Bonds, Bills and Inflation 1926 – 2017), From Stocks, Bonds, Bills and Inflation (SBBI) Yearbook, By Roger G Ibbotson and Rex Sinquefield, updated annually.
[5] Ibbotson SBBI (Stocks, Bonds, Bills and Inflation 1926 – 2017), From Stocks, Bonds, Bills and Inflation (SBBI) Yearbook, By Roger G Ibbotson and Rex Sinquefield, updated annually.
[6] “Bear markets may not be as ferocious as they appear”, Mark Hulbert, Wall Street Journal, March 8-9, 2014.
[7] “Time, diversification and the volatility of returns”, JP Morgan Asset Management Guide to the Markets, Page 63, March 31, 2018
[8] My position in this article is that we are talking about someone whose withdrawals are not substantially reducing their principle over their lifetime. No portfolio can overcome excess withdrawals over a lifetime, no matter how well the investment markets perform. A good analysis of your lifetime cash flow should be conducted before you begin a distribution plan.