Resist the Temptation to React to the Present, Guess the Future

Many investors felt rattled by market behavior recently, with the S&P 500 index dropping over 6.5% in just over a week, starting on October 4th. The financial press, as always, was quick to try to capitalize on investor fears, warning of trade wars and a potential global economic slowdown. This type of volatility often provokes some investors and managers of active mutual funds to shift their portfolios out of equity investments (stocks) and into fixed income (bonds and cash).

However, this strategy tends to be unsuccessful in the long run. Consider a recent example. In the lead up to the 2016 presidential election, many investors and money managers moved to cash, and then the S&P 500 jumped around 30% over the subsequent two years. If, instead, investors or mutual fund managers adopt a disciplined strategy that involves sticking to portfolio targets regardless of market dips and not trying to predict what the market will do next, they will generally enjoy higher returns over the long term.

That is one of the main reasons why we advocate that our clients invest in passively-managed mutual funds, such as those offered by Dimensional Fund Advisors (DFA).  Actively-managed mutual funds that react to present market conditions or try to guess future conditions tend to underperform compared to their relevant indexes– in part because they fail to perfectly anticipate movements in the market and in part because they generally have much higher fees than their passively-managed counterparts.  DFA performs an annual study of U.S.-based mutual funds and, in their 2018 study, found that only 14% of equity funds outperformed their relevant benchmark after costs over the past 15 years.  In contrast, 73% of DFA funds outperformed their benchmarks over the same time period.  The video below explains DFA’s findings in detail.

Investing can be a bumpy ride, but when you have a financial plan and an investment strategy that takes into consideration the inevitable volatility (even capitalizes on it through portfolio rebalancing) but does not try to guess when and how it will occur, dips in the market do not have to be a source of fear.  If you have a disciplined strategy, as we do for our clients, hopefully you can tune out the noise and focus on the aspects of your life that are most important to you– your family, your friends, your job, your hobbies– rather than the latest doomsday headlines.  As always, we are here to help and provide encouragement every step along the way.