The oft-repeated phrase for almost every family road trip in recorded history—“Are we there yet?”—is also appropriately asked by investors experiencing stock and bond markets in 2022. Although we’re not traveling together in the back of a wood-paneled station wagon to grandma’s house halfway across the country, we are all experiencing an uncomfortable journey of volatility.
Questions that I hear and questions I’m asking myself along this investing volatility voyage include:
- Have stocks reached their bottom for this cycle?
- Has the Federal Reserve reached its limit on increasing interest rates?
- Have mortgage rates peaked, or will they continue to move higher?
- When will inflation come back down to “normal” levels?
- How long can unemployment rates stay at record lows?
These questions are all very interesting to ask, but we need to understand that there is no way to have a definitive answer to any of them. Moreover, the answers may not be necessary in order to be a successful investor. The answers may impact your portfolio and your financial plan, while at the same time, getting those answers may not tell you exactly what’s to come or what turn you should take next.
For example, the policy of the Federal Reserve has an impact on interest rates and, therefore, financial assets like stocks and bonds. Bonds, in particular, are sensitive to the changing of interest rates, as there is a direct relationship between yields and market prices. That said, the changes that have already taken place so far in 2022 as described in our recent article, Why Now? Context for Recent Volatility., are more impactful on bond prices than future rate increases may be. In quantitative terms, the last one percent increase in interest rates will have had a greater effect on prices than a potential future shift of one percent can have. Additionally, the yield received from holding bonds today is many times higher than just last year, regardless of the direction of future rates. If you liked bonds then, you should love them now
One challenge we face in this journey is understanding how best to measure success as an investor. Is it solely based on the rate of return on our portfolio, and, if so, over what time period? Is it based on the size of our balance sheet, or our goals reached? Do we base our success on the actions we’ve taken, or the risks we’ve avoided?
In situations like we are in today, it often feels like action is needed, regardless of the risks. It feels that if we are not individually “doing something” dramatic, we are willingly subjecting ourselves to the will of the market. But isn’t that the same thing we do when markets are going up? Aren’t we more than willing to accept market rates of return when they’re strongly positive? Why does the downside feel more painful than the upside feels good, and why do we feel the need to intervene?
Entering 2022, we were coming off of over a decade of incredibly strong stock market performance, which grew the balance of our collective investments to record highs. At the same time, we were experiencing inflation that was the lowest in 50 years. Said differently, the value of our assets (stocks, bonds, houses, etc.) was worth more than it had ever been before, while at the same time the things we spent our money on were hardly increasing in price.
This combination of events was the perfect storm for a persistent experiencing of the “wealth effect” within our economy. The wealth effect is a theory suggesting that when households have more wealth, whether through earnings or because of the increased value of their assets, they tend to spend more and are more optimistic about future financial goals, which may have the impact of perpetuating further financial gains. If the value of our assets is increasing, all will be well; right?
When I think about this concept, I think of a commercial that aired in the mid-2000s by a large financial institution revolving around the amount of money that will be necessary for a successful retirement. They coined the campaign and concept, Your Number. For many, this resonated, as it gave a tangible objective to be reached. Who wouldn’t want to have such a goal? In such a world, once you reach your number, the game is over. You’ve won, and you’re destined for a future without worry or concern. But what they don’t mention is what to do when your portfolio falls below that number as it may have in a bear market like 2022. Do you need to go back to work or stop spending? I certainly hope not.
Although I think that at a base level this concept is helpful to get people pointed toward a goal, it’s very misguided as to why that goal is important. The reality is, there is no magic orange number for each of us to carry around under our arms and be reminded of every day. There is a true downside to the wealth effect. When the numbers don’t continue to go up at the same rate or in the same manner as they have in the past, there can be an equally impactful downside risk to how we feel about our financial stability. That is why it’s important to move away from a tendency toward a wealth effect mindset and how a number plucked from the air may guide our spending and ability to have a successful retirement. Rather, I’ll assert that the more important way to think about wealth is through what I call the Plan Effect.
The Plan Effect is the security you feel by having a well thought out and rigorously tested financial plan supporting your spending and gifting strategies, not simply increasing spending according to the value of your portfolio at any given point in time. The Plan Effect is the understanding that with the strong foundation of a financial plan that accounts for your current state, potential future outcomes, taxes, desires, goals, dreams, and risks on the horizon that may affect you in the future, you will be OK. The Plan Effect might not feel as fun at times as the wealth effect, in that you’re not just focusing on the proverbial scoreboard to see if a new digit is added to the total, but hopefully the sense of ease, comfort, and stability that it provides in up markets and in down, are worth the effort.
NOTE: The information provided in this article is intended for clients of Carlson Capital Management. We recommend that individuals consult with a professional adviser familiar with their particular situation for advice concerning specific investment, accounting, tax, and legal matters before taking any action.