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5 Lessons From 2015’s Rocky Market

John F. Wasik

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This past year in the markets reminded me of a narrow, treacherous road I once drove in Western Ireland to get to Slieve League, sea cliffs that towered over the Atlantic Ocean on a blustery day. There wasn't much room for error, but I knew if I just stayed the course--that is, if I simply kept on the road--my family and I would be fine.

Emotions naturally get churned up every time we see significant market volatility, as we did in tempestuous 2015. What lessons did we learn, and how can we apply those lessons moving forward?

Accept That Volatility Will Continue

There's no credible market observer who's willing to say "the worst is over," or that "market volatility is a thing of the past." We are going into 2016 facing significant global issues, as well as rising interest rates--both of which may cause some market tumult. So, you either embrace volatility as the cost of staying in the market, or you retreat to cash whenever you get the yips--which is always a bad idea because no one can perfectly time the market. You'll miss the best time to get out and the best time to get in, which translates into consistently losing money. There have been a number of studies on the difficulty of market-timing. Here's a recent one.

"Volatility is what also gives us up markets," reminds Tim Steffen, director of financial planning for Baird in Milwaukee. "If you're spooked by what's going on in an asset class, that means you have too much in that asset class."

Maintain a Long-Range Plan

Having a long-range plan is essential during periods of market volatility. Why? Long-term plans help you make better investment decisions that are less tied to market movements. How much do you want to keep invested in stocks, bonds, cash, and alternatives? Do you have an investment policy statement that outlines your plan? Has your overall allocation drifted away from your targets? If so, do you need to rebalance?

Of course, any anxiety you experience over losses in any given category should be addressed when you review your portfolio at year-end or early next year. Just keep in mind that if you need to make changes, limit those changes to once or maybe twice per year. That will limit any overreaction.

Consider Alternative Investments--in Moderation

If you're squeamish about extreme market moves, you might want to consider alternative investments that don't move in lockstep with stocks or bonds. According to a recent survey by Pensco Trust Company, nearly two thirds of those investors surveyed say they have increased their allocation to alternatives or plan to as a result of the market volatility. The lesson here is that you don't have to be wedded to a narrow stock/bond portfolio. You can often reduce volatility by going outside of that box.

Assets that are often not directly linked to the stock market include real estate investment trusts (REITs) and direct property ownership; master limited partnerships (MLPs); commodities; and private equity. While those vehicles can be tough to understand and expensive to invest in, consider a wide range of alternative mutual funds and exchange-traded funds (ETFs) that package these assets in one bundle.

The problem with some alternatives--such as bear-market funds--is that their long-term records are terrible. Sure, they can rise when there are short-term hiccups in the market, but they don't usually make good long-term, buy-and-hold vehicles. You have to be careful with them and use them sparingly--if you use them at all.

Redefine 'Income'

Defying expectations, yields remained low throughout 2015. And even though savings and bond yields are expected to rise in 2016, the increases will likely be modest. MLPs and REITs are options if your priority is boosting income, but they have risks of their own. REITs, for example, are sensitive to interest-rate movements, but are tied into unrelated conditions in the commercial and industrial real estate markets. MLPs are linked to mostly energy companies, which are subject to movements in the commodities markets, where the price of oil and refined petroleum products has fallen in the past year.

It also helps to have an open mind as to what constitutes "income." Income isn't just interest from a bond fund or savings instrument. Think total return--that is, ways to increase from wealth from different sources. It could be dividend payments from a lower-volatility, dividend-stock fund or ETF. The important lesson here is to have a diversified basket of income-oriented vehicles that don't move in the same direction when the market turns south.

Embrace Global Bargains

Despite a somewhat rocky 2015, many market observers think U.S. stocks remain overvalued. "Notwithstanding the recent volatility, U.S. equities remain expensive by historical standards," writes Jack Ablin, chief investment officer for BMO Private Bank in its December Macro Investment Strategy Chartbook. "The S&P 500 is trading at 25% above historical median when gauged against revenues. At the same time, revenue and profit growth are negative. S&P profits declined 4.4% on a 3.7% revenue drop last quarter."

Broadening your holdings to include "value" global stocks may help offset the tendency to overconcentrate in U.S. stocks. You may even be able to sidestep, to some extent, the common error of buying the most-popular stocks when they are the most expensive.

If the past year has taught investors anything, it's that they need to be patient to ride out the storm. There will certainly be other global calamities to rattle everyone's nerves. That's the nature of the beast. Yet, if you have long-term objectives--such as retirement, saving for college, or building an estate--you need to stick to a route that's going to get you there. Just keep in mind the road will likely zigzag. If the myriad switchbacks don't make you dizzy, you'll make it to the financial summit of your choice.