It’s too late to sell and too early to buy, which means most investors should be sitting tight.
How can you keep clients from making panicky decisions in the days ahead? As of Monday’s market close, the S&P 500 was down 11.2% from its all-time high, officially in a correction, and yet rebounded at Tuesday’s open. Your phone may be ringing incessantly and your inbox overflowing. Buy?? Sell?? Hold??
Your clients may pay you every year, but it’s at moments like this that you prove your worth. Up or down, here are five vital takeaways to remind your clients of (and perhaps yourself):
COUNT THE CASH
For rational investors, the past week’s stock market declines have no immediate economic impact — unless they need to sell shares to buy groceries. How can you drive home this point? If you have retired clients, add up their bond and cash holdings, and compare it to their desired portfolio income. There’s a good chance they have at least five years of portfolio withdrawals sitting in conservative investments, which is plenty of time for stocks to recover.
Meanwhile, your clients who are still employed have a paycheck to cover their living expenses, so they also don’t need to sell. In fact, their regular income is like collecting a generous stream of interest from a massive bond portfolio. So what if their stocks are worth a little less? They still have their bonds — both the ones you bought for their portfolio and the one that generates their paycheck.
The markets anticipate the future, but the future that’s being anticipated is typically just 12 months’ away. The Chinese economy appears to be slowing, though it’s far from clear how bad it’ll get or what the impact will be on U.S. economic growth. Still, twitchy securities analysts, market strategists and money managers — who are fretting over their own investment performance for this year and next — figure it’s better to be safe than sorry, so they’ve been heading for the exits.
You should explain to your clients that the future that concerns them isn’t arriving next year. Their time horizon is completely different from that of the Wall Street investment community that’s driving today’s market volatility. So what if the economy dips into recession and corporate earnings take a short-term hit? By the time your clients need to sell stocks to pay living expenses, this month’s market indigestion will be long forgotten.
If your clients need further reassurance, remind them about late 2008 and early 2009. At the time, many television talking heads feared the financial world was on the verge of collapse. Those who ignored the babbling, and stuck with their stocks, have seen their portfolios triple in value since early 2009.
CHRISTMAS COMES EARLY
People run screaming with excitement to the mall whenever there’s a sale, and yet run screaming with terror from the stock market whenever there’s a sale. This makes no sense.
If you use the shopping analogy with your clients, you might admit that it isn’t perfect. The jeans that you can buy for 50% less on the day after Christmas are the same jeans you could have bought a few days earlier at full price. By contrast, share prices have fallen because there’s concern that the fundamental value of U.S. corporations has also declined, with corporate earnings likely to grow slower than expected.
That may be true. Still, share prices are down almost 10% over the five trading days through Monday’s market close, but it’s inconceivable that the fundamental value of U.S. corporations has also deteriorated 10%. Change in the real economy simply doesn’t happen that fast. The upshot: Stocks must be better value than they were five days ago, so clients should be more enthused about their holdings, not less.
THINK LIKE A BOND INVESTOR
If bond prices fall, driving up yields from 3% to 3.5%, investors immediately grasp that bonds are better value. How can you get clients to see the same silver lining in tumbling stock prices? You might discuss how much in corporate earnings they are buying with every $100 invested.
What we’re talking about here are earnings yields, which are the reciprocal of price-to-earnings ratios. Instead of dividing a stock’s price by its earnings per share, you divide the earnings per share by the stock price.
To help clients understand what has happened, mention two numbers. At the May 2015 market peak, the earnings yield on the S&P 500 was 4.7%, meaning every $100 invested bought $4.70 in annual earnings, with those earnings expected to grow over time. As of Monday’s market close, the earnings yield was up to 5.2%, so buyers are getting $5.20 in earnings for every $100 invested. Nobody knows what will happen to share prices in the weeks and months ahead. Maybe even the next few hours ahead. But today’s higher earnings yields are another indicator that stocks are better value.
WALK THE LINE
Looking for another way to get clients to focus less on the market mayhem and more on underlying value? You might talk about the difference between the market’s investment return and its speculative return.
I estimate that U.S. stocks will have an average annual investment return of 6% over the next decade. That’s comprised of a 2% dividend yield and 4% growth in earnings per share, while inflation runs at 2%. But year-to-year returns will vary from this 6% growth path. As the twitchy Wall Street investment community vacillates between greed and fear, the market’s speculative return will often overwhelm the investment return.
But you should encourage clients to stay focused on that 6%-a-year growth path. When stocks fare significantly better than 6% in any 12-month stretch, they should mentally prepare themselves for a future period of weaker results. Conversely, when stocks falter, they should comfort themselves that good times will eventually lie ahead. Over the past 12 months, the S&P 500 has fallen roughly 3%, once you factor in dividends. The implication: To get back to 6% a year, we have some catching up to do.
Jonathan Clements, a new Financial Planning columnist in New York, is a former personal finance columnist for The Wall Street Journal. He’s author of Jonathan Clements Money Guide 2015 as well as the forthcoming How to Think About Money. He’s also former director of financial education at Citi Personal Wealth Management. Follow him on Twitter at @ClementsMoney.