Millennial Maiden Voyage: Down the Recession Trail
Written by Tami Acree
This article is primarily directed toward Millennials; that is, people born in the late 1980’s and the 1990’s. However, the recommendations stated below reflect principles that apply to every generation. If you have successfully navigated through several market cycles throughout your investing years, feel welcome to forward this article to someone who has not yet had your experience.
I participated in Track and Field during my college years. On certain days, we were expected to run a two mile trail that rambled alongside the train tracks that bordered the edge of campus. Each time someone ran this particular trail for the first time, it was referred to as their “Maiden Voyage down the Railroad Trail” (I would recommend running this trail for yourself, but alas, it no longer exists due to building expansions on my Alma mater’s campus).
Switch “shoes” with me for a moment and turn your attention to the stock market. We have been experiencing a bull run for the past eight years. Many of us Millennials have yet to personally experience a recessionary period in our accumulating years. Most of us were in high school or college when we watched our parents struggle through 2001-2002 and 2007-2008; and maybe that affected some families more than others. All we have heard since graduation is noise about the markets hitting “all-time highs” and “plunging 20 percent” in the same year and many of us don’t know what to make of it or how to invest prudently for the stage of life we are in.
The fact is, albeit with a few speed-bumps along the way caused by external world events, equity markets have been in recovery mode since the beginning of 2009. That makes for an eight year bull market run, with equities on the rise, and bond interest rates remaining low and inflation tame.
Now, one fact history (and also common sense) will show you is that stock and bond markets have cycles. There is no way to time when the market will correct; it is not every “x” number of years as some experts claim. The hundreds of factors that affect the markets make it impossible for anyone to accurately predict market movements year after year. And logically, bull markets cannot last forever. So whether it is next year, or in three years, or five or ten years, there will be another market correction. It will be the first one that most Millennials will truly experience; our “Maiden Voyage down the Recession Trail”, if you will. When the time comes for us all to go down that path, there are a few factors to keep in mind that will help Millenials prepare for a recession.
There are only two ways to lose money in a down market.
The first way to lose in a recession relates to the type of investment you hold. If you own an individual stock or bond and the issuing company goes bankrupt, you will lose your investment. Case in point, my grandmother owned a bit of company stock in the bank where she was employed for years. That bank went belly-up in 2008, and her securities there became worthless. Individual stocks and bonds such as this have high specific company risk. We’ve all heard of Enron, Blockbuster and Radio Shack – tremendously prosperous companies at one time that saw a rapid decline and no longer exist. There is potential to lose the value in your investment forever.
But say you don’t have a large exposure to individual stocks and bonds. Are you safe in a recession? This leads to the next point.
The only other way to lose money in a recessionary period is to SELL. It is called “realizing” your losses. Investors without a strategy tend to bail on investments at the worst possible time. For example, if you owned a fund in the Emerging Market sector in 2008, you could have possibly experienced a decrease in value of -53.33%. You still owned the same number of shares; they were just worth less on paper. If you got scared and sold that investment at the end of 2008 and realized the loss, you would have been left with a wad of cash that was 53% less than the value of your investment in the previous year. You would not have been alone; this was the behavior of many investors. You would have also missed out on the 78.51% positive return the Emerging Market sector came back with in 2009 (data taken from the Eaton Vance Monthly Market Monitor). A more recent example is November 2016. Market analysts were preaching doom and gloom leading up to the election, and many investors were tempted to go to cash out of fear of the seemingly apparent downturn. Those who did sell realized it was the wrong time when they missed out on the unpredictable growth we have experienced in the year since.
To protect yourself from these two potential pitfalls, consider taking the following steps:
1. Hire a coach.
According to a white paper released in September 2016 by one of the world’s largest investment companies, an advisor can add approximately 1.5% to your return by providing behavioral coaching. A fee-only advisor will help you create a long term game plan and then stick to it. They talk you down off the ledge when you are about to make an emotional decision. They act as your emotional circuit breaker. They encourage you to keep saving. They reiterate that you can’t time the markets for the best moment to buy or sell. They stand as the objective third party voice of reason to keep you from unintentionally making choices founded in fear or greed.
2. Strategically determine your Asset Allocation.
Your asset allocation (how much should you have in equities vs. bonds and cash) dictates upwards of 90% of your return. The Financial Analysts Journal attributes 91.5% of variability of quarterly volatility to asset allocation; security selection accounts for 4.6% of return, and market timing accounts for just 1.8% (“Determinants of Portfolio Performance,” Financial Analysts Journal, Brinson, Gary P., et al, 1986). Your asset allocation should be specific to your time horizon, investment tolerance and goals.
3. Invest in mutual funds and Exchange Traded Funds (ETF).
Rather than investing in one company with a percentage of your money, owning a portfolio of funds gives you a small piece of ownership in hundreds of companies. The likelihood that all of these companies will go bankrupt simultaneously and never recover is extremely unlikely. If you do own an individual stock position to which you have a strong attachment, we recommend keeping your exposure below 10% of your portfolio.
4. Highly diversify your portfolio.
Own a variety of funds spread out over several asset classes. You could be described as having “all your eggs in one basket” if your portfolio consists of only large US companies. Diversify your portfolio by owning large, medium and small cap domestic funds, international funds, real estate funds, etc. By design, portions of your portfolio should behave differently than others. Since it is near to impossible to predict which asset class will be the winner and which will be the loser this year, make sure you own the appropriate amount of each asset class. This will allow you to take profits from the class that outperforms and obtain more shares on sale of the class that under-performs in a given period.
The only certainties are death, taxes and market cycles (forgive my adaptation of the old saying). The question is not if, but when a market correction will occur. With these tips in mind, you can successfully weather your maiden recession voyage with sails and emotions intact.