It’s a brand new year, and that means champagne, Auld Lang Syne, weight loss resolutions, and lots of predictions. I Googled “2018 predictions,” and I got 78,900,000 results in 0.49 seconds.
I’m always fascinated by the confidence implied by the predictions I read at this time of year. MarketWatch columnist Jeff Reeves offers 18 predictions for 2018, including a 9% increase in the S&P 500, a rebound for big oil, and a short-term “crash” in Bitcoin. Gallup News posted their predictions with polling results. Although 79% of Americans believe 2018 will be a “troubled year with much international discord,” 52% expect a year of economic prosperity.
CNN’s Crystal Ball proved entertaining. When asked, “What will the Dow Jones end at in 2018?” the prognosticators had quite a range of responses. Joey Jackson, a legal analyst, confidently predicts “28,000 (Enuf said)” while Jeff Yang, an opinion contributor, has a grimmer outlook. “Honestly, I’m just hoping we’re all still around at the end of 2018.” How’s that for depressing?
As a Gen Xer, all these predictions remind me of Biff Tannen, the bully in the classic 1980s Back to the Future trilogy. For anyone who hasn’t seen them, the movies chronicle the journeys of Marty McFly (played by Michal J. Fox) as he travels through time in a DeLorean time machine created by the eccentric Dr. Emmett Brown (Christopher Lloyd).
In Back to the Future Part II, the loathsome Biff Tannen acquires a sports almanac containing results of all sporting events from 1950 – 2000. He travels back in time and gives the almanac to his 1955 self, who then uses the almanac to “predict” the outcomes of sporting events for immense financial gain.
If only we had our own almanac of world events for 2018 and beyond. Making predictions about politics, economics, technology, and the markets would be a breeze. However, unless your future self shows up in a time machine, no such almanac exists for us today. So what should our investment approach be as we head into 2018? Two important themes can help guide us:
1. Acknowledge that market declines are a normal part of investing, and expect them. JPMorgan’s quarterly Guide to the Markets includes a graph which shows the annual returns of the S&P 500 along with its corresponding decline that year. From 1980 through 2017, the S&P 500 has experienced positive returns in 29 of 38 years. But you’ll see in the graph below that the market has experienced a decline, represented by a red dot, at some point during each and every year. You may find it interesting that the average decline within any given year is nearly 14%! Knowing that market declines are normal, we should prepare ourselves for them, both psychologically and in how we design our portfolio. Don’t let downturns surprise you. While they are unpleasant, they are to be expected.
2. Focus on what you can control. Since we cannot predict the timing, duration or depth of a stock market decline, we should focus on what we can control. In investing, there are really only four things:
- Risk: The way we prepare for market declines is by diversifying the portfolio across lots of investments that don’t act the same way at the same time. We create that allocation specifically to address the risk tolerance and risk needs of each individual client. More conservative portfolios hold more bonds. More aggressive portfolios hold more stocks. In this way, we can manage the level of risk that we take.
- Expenses: Keeping the internal expenses of a portfolio low is a big predictor of future success. We control these fees by using institutional mutual funds and ETFs with very low expense ratios.
- Taxes: For clients who have investments in taxable brokerage accounts, we minimize taxes by using ETFs and mutual funds with tax management as part of their mandate. We also take advantage of tax loss harvesting opportunities when they arise.
- Our Behavior: Most important of all, controlling our response to the news (including predictions for 2018) is the biggest determinant of investment success. If we allow our emotions to drive investment decisions in reaction to bad news or predictions about future market movements, our well-designed plan is for naught. As advisors, the most valuable thing we do for our clients is helping them avoid making behavioral financial mistakes.
Focus on what you can control, be prepared for inevitable pullbacks, and keep your eye on the long term. If you do those things, you won’t need an almanac from the future to prosper in 2018.