When investors seek to earn a return in the market, they put their capital at risk. What is the risk investors fear and what are, perhaps, the bigger risks investors seem to be overlooking?
You may be spending time stressing about the volatility of stock market investing, but inflation may be a bigger worry.
The concerns over the stock market have been triggered by recent sharp, but not apocalyptic, declines in the S&P 500 and Nasdaq. The S&P traded as low as 4199.85 on March 7th which was -12.8% from its all-time high. The Nasdaq traded as low as 12,555.35 on March 14th which was down 22.6% from its all-time high.
While we understand why those numbers raise eyebrows, could money that isn’t in the stock market see a larger decline in value over the long-haul?
The Risk of Inflation: Trailing 12 month inflation was announced for February at 7.9%1. That means if you keep your money in a bank account, your spending power has been reduced by 7.9%.
The Risk Of Market Declines: On the other hand, the equity markets have been volatile and frequently declined -10% (a correction), -20% (a bear market) and sometimes more. That said, historically the stock markets have always recovered after a correction or a bear market for patient investors.
So, on the one hand we have inflation; on the other hand, we have an equity market correction that is emotionally stressful but historically, if you stayed in your seat, the equity markets recovered and went on to set new highs.
Which Should You Fear?
Behavioral Finance attempts to answer the question “Why do people fear equity market corrections more than inflation?”. Humans are hard-wired to pay more attention to moving objects. The inflation rate only gets reported once a month. Equity market movements are being reported literally every second throughout the trading day. Put into scientific terms, equity market information is more salient than inflation information, and people tend to mistake more salient information as more important.
How is an investor supposed to manage those risks they fear and the, perhaps, bigger risks they may be overlooking?
The answer to this seems to lie in holding a diversified and purposeful portfolio.
ONE – ‘Trust the Evidence’ and keep some of your money in the market. Throughout history, the Equity Markets have outpaced inflation over statistically significant periods of time.
TWO – ‘Trust the Evidence” and keep a purposeful quantity of money in Short-Term Investment-Grade Fixed Income along with an allocation to TIPS – Treasury Inflation Protected Securities.
A professional wealth manager should be willing and able to collaborate with you toward constructing a well-reasoned all-weather wealth management plan that assists you in market declines, defends you in the event of inflation, improves the chances that you grow wealth for later and enables you to sleep at night.
1 – The Bureau of Labor Statistics (BLS) announced on March 10th, 2022, that “The all items index rose 7.9 percent for the 12 months ending February. The 12-month increase has been steadily rising and is now the largest since the period ending January 1982. The all items less food and energy index rose 6.4 percent, the largest 12-month change since the period ending August 1982.”