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Ostriches, Austin Powers, & Bond Coupons

March 28, 2020
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Before I get into this blog, let me first remind you of the following: 

The events that transpire in a single week in 2020 will not be the deciding factor in the success or failure of your financial plan. 

...Now that that's out of the way, let's talk about what transpired in a single week in 2020: thisweek.  

This week we got a little reprieve from the onslaught of the fastest bear market in history.

On Thursday the Dow marked its best three-day gain since 1931, while it was the best such gain for the S&P since 1933. Despite Friday's decline, the Dow booked a 12.8% weekly advance, its strongest since 1938, while the S&P 500 rose 10.3% for its biggest such jump since 2008. The Nasdaq's 9.1% weekly rise was the biggest since March 2009. 

As we know, the catalyst for the rally this week was the historic stimulus package approved by congress and signed by President Trump.  Later this weekend I'll be sending out some commentary on that bill, how it may affect our financial planning efforts over the next few years. 

The Dow's 21% surge in 3 days technically puts it back in a bull market (20% gain is the threshold)--but I think we all realize that volatility is here to stay. 

While the rebound this week has been nice, we are still considerably lower than our pre-crash levels. Since their highs earlier this year, the Dow still stands 26.8% below its record high, the S&P 500 is down 25% from its Feb. 19 peak and the Nasdaq Composite Index is off 23.6% from its all-time high.

Still, let's take a breath and pat ourselves on the back for not making adjustments; reacting and missing the best days can be damaging.

A couple weeks ago I sent this graph highlighting the impact of missing the big days for the market: 

The chart above shows the annualized compound return of the S&P 500 Index going back to 1990 and illustrates the impact of missing out on just a few days of strong returns.

Ducking in and out of the market is akin to market timing, and that is difficult because a substantial proportion of the total return of stocks over long periods often comes from just a handful of days. Since investors are unlikely to be able to identify in advance which days will have strong returns and which will not, the prudent course is likely to remain invested during periods of volatility rather than jump into and out of stocks. Otherwise, an investor runs the risk of being on the sidelines on days when returns happen to be strongly positive.

We know this week was a nice rebound and we know we can't react, but it's hard to sit back and watch our wealth fluctuate. I get it. 

So how can we embrace the discipline we know is right, while increasing our odds of being able to stick with it?

The answer is tricky, but here are some options:

The above maneuver would probably help us avoid seeing the fluctuations through sticking our heads in the sand, but that seems a little uncomfortable. 

How about cryogenics?

Much like Austin Powers, perhaps we could buy-or-hold our investments and then cryogenically freeze ourselves only to wake up years later when this is all over.

I'm pretty sure the SEC frowns upon advisors who involuntary freeze their clients... and I don't believe we have the technology yet. 

Maybe someday!

Jokes aside, it is actually very important not to panic based on short term fluctuations. 

There was a simpler time when we wouldn't have been able observe the fluctuations in our portfolio even if we wanted to. 

Here's an example: 

The image above shows a $100 bond from 1927.

The certificate portion of the bond is on the right, and surrounding the bond on the left and bottom are the coupons

Here's how it would work: 

  • Investor buys the bond for $100. They provide their $100 to the borrower and the borrower gives them the above document. As we know, bonds pay investors interest, or "coupon", payments. The term coupon refers to the removable tabs on these bond certificates. 
  • The owner now goes home, sticks the bond in their desk drawer, and forgets about it until it's time to clip a coupon.
  • The owner of the bond would simply clip off a coupon from this bond, send it in to the entity that issued the bond, and then the issuer would mail a cash payment to the bond owner. This is where the term clipping coupons comes from when referring to capturing bond yields. 
  • When all coupons are clipped, the bond has reached maturity and they can go get their initial $100 back from the borrower. 

Here' why I'm highlighting this example: 

The entire time the bond owner was holding that bond, clipping coupons, and receiving payments, there would have been A LOT going on with interest rates, the economy, the creditworthiness of the borrower, etc....

All of those things would affect the price of the bond if the bond owner wanted to try to sell it, but since they simply planned on holding the bond, collecting their payments, and allowing it to mature, they don't need to care about that short term noise going on with the bond's price. 

In these simpler times, there was no CNBC, no client web portal, no weekly performance reports, and no TD Ameritrade Login to allow investors to track the value of their portfolio on a minute-by-minute basis. In order to value their portfolio they would need to actually sell everything. Which we know doesn't make sense until you actually need the money.

Of course, I strongly believe in the transparency we have access to and the tools I've invested in for clients, but sometimes it's damaging to our short-term psyche. 

...Another example of this kind of pricing behavior is your personal residence (if you own your home).

Your home value is constantly fluctuating but you don't have to acknowledge it unless you want to sell. But if nothing has changed in your life and you don't plan on moving, then you don't need to care what the current price of your house is. It only matters when you plan on moving. 

Relating this example back to your portfolio, 

moving = withdrawing funds from your investment and spending them. 

Losses in your portfolio are painful, but they only really matter when you plan on selling so you can spend the money.

Still, they feel like 'losses today' when we know they're really investments for the future. That's a normal way to feel. 

Just as I mentioned when I opened this message, what happens in a single week or month in 2020 will not be the deciding factor in our financial plans --I refuse to allow the recent events to affect us over the long term, we'll get through this. 

As much as you possibly can, try to think of your investments like that bond and put them away in the drawer for later.

In the meantime, clients may notice me making trades to harvest tax losses and rebalance the portfolio, while not abandoning our longer term approach. 

If you'd like to discuss these approaches, just reply to this email and let me know when you're free to chat. Or schedule a discussion here: 

https://calendly.com/hardingwealth/market-volatility-discussion

For extra credit, here's a quick overview of Tax Loss Harvesting: 

https://www.investopedia.com/articles/taxes/08/tax-loss-harvesting.asp