Adapting to Market Conditions

by / Thursday, 19 September 2013 / Published in Market Conditions

Focus On What You Can Control

The markets go up and then they goes down. Investors try to decipher headlines about the “Fed’s” next move or what bill Congress will or will not pass this year. The average investor, as is perhaps best illustrated in various studies from DALBAR and others, over-corrects to changes in the market as they shift their investments based generally on the feeling in their gut triggered by the last tick of the Dow Jones Industrial Average or S&P 500. Investors often want to make a change for the sake of change, sometimes based upon a special date on the calendar, or other times out of pure fear. Advisors, too, can be complicit in this tragedy by offering no risk management guidelines along the way, and thus exposing their clients to situations where their emotions are almost encouraged to get the best of them. In the end, the average investor lags both the market and, up until recently, even inflation over time.

In short, this can best be summed up as the “Behavior Gap”, the difference in returns due to behaving badly. The image below displays the results of this poor decision-making by investors. The average investor has shot themselves in the foot, barely even beating out inflation, as the 20-year average annualized rate of return for investors is +4.25%, with inflation biting at investor’s heels at an average annualized rate of +2.43%. The investor’s return falls well short of the 20-year average annualized return of the S&P 500’s +8.21%.

As we look at the current market we must remember to make a distinction between things we can control in the market and things that we can’t. For instance, risk is something we can manage effectively within accounts, while outcomes and market returns are things we very much cannot.

The Story of the Old Farmer

An old farmer’s horse disappears one day. His neighbors, noticing the horse is missing, gather at the farmer’s house one evening after farming and remark upon his terrible luck. The old farmer shrugs and simply says, “We’ll see.”

The next day the horse returns and brings with it several wild horses that the farmer can use to speed up his plowing in the field. The neighbors gather once again and remark on his good fortune. The old farmer shrugs and says, “We’ll see.”

The following day the farmer’s son is thrown while trying to ride the horse and breaks his leg. The neighbors again gather and offer their sympathy and condolences for his misfortune. Again, the old farmer shrugs and says, “We’ll see.”

The day after his son breaks his leg, officers from the Emperor’s Army arrive to seize all able-bodied young men in the village for mandatory service. The neighbors gather to commiserate and tell the farmer how fortunate he is that his son recently broke his leg and was therefore spared from the soldiers. Again, the old farmer shrugs and says, “We’ll see.”

The wisdom of the old farmer is that we can never know just where the winds of fortune will blow, or even how they will chart their course and, ultimately, what it may mean for the future. Knowing this, we don’t throw our hands up in defeat and refuse to farm. We adjust our expectations, make certain we are using the best farm implements we can find, and go to the fields every day knowing that we are neither masters of our fate, nor victims of it, but are instead students of it.

At Kiker Wealth Management we understand the road to financial security is a long journey that will include some frustrations or set-backs. Where many people see defeatism and hopelessness, we see something altogether different; something positive and calming in the fact that we are very aware and conscious of that which we cannot know. While the old farmer’s neighbors are content to ride the roller coaster of fortune’s highs and lows, often overestimating the role they play in bringing them about, the old farmer is at peace with the fact that whatever fortune may bring – good or bad – he plays no role in its whims. By letting go of the things we cannot control, we allow ourselves to focus upon those aspects of life in which we do have greater influence.

We don’t complain, we adapt.

How many times have you observed someone visibly shaken by something like a longer-than-expected wait at a cashier because the register ran out of paper, or at an ATM that for some reason just won’t read the card or ran out of cash, or even at an airport over a flight that despite all odds has somehow failed to depart at its scheduled time? What positive outcome could possibly come from letting such events get your blood pressure up? Could you control any of those outcomes? Could you realistically do anything differently to avoid a similar outcome in the future? The answer is largely “no” on both fronts, and would suggest to the  airline passenger that we simply find something productive or at least pacifying to do with our new found spare time at Gate B31.

As Kiker Wealth Management we understand that we have virtually no control over what the markets will do or when they will do it, we simply control how we will respond to it and how we will help you make smarter decisions. We are powerless to alter the course of the financial markets, but we take full responsibility for our exposure to any specific market and the rationale behind it. By using, and following, indicators that are based in simple supply and demand relationships we essentially agree to admit failure when the market dictates we are in poor investments. We don’t complain, we adapt. We don’t know why the market rejected our investments, only that it did. We don’t know everything about the market, we simply know “what is”.

Admitting defeat on a stock, or a sector, or an overall turn in the market isn’t always (if ever) pleasant, but it is necessary in preserving wealth over any extended period of time. Just as failed investments must be taken in stride, we must also accept that we can’t know all of the reasons we are entering an investment when we buy. Our tools are simply designed to increase our odds of success and add a contrarian component to our discipline. Our tools don’t act like a Wikipedia of market turns, giving thorough verbal definition to every change in the market – but wouldn’t that be nice? The point is we are content to accept that which we do not know because we have a set of tools to guide us through the good and bad of the markets, to deal with the unknowable aspects of the market. We let go of the ties that emotionally bind so many investors to the dramatizations echoed on the financial media. We have no control, and that is empowering.

The old farmer isn’t necessarily better than his neighbors; he’s just better at focusing on the things that are important – the things he can change, and ignoring the things he cannot. So, too, are we at Kiker Wealth Management better at focusing on the things we can change within a portfolio such as the risk profile, the market exposure, using tools such as options to hedge risk, and take advantage of opportunities; and ignoring the things we cannot, such as what scandal will be uncovered or what country will default on their debt next. We will adapt along the way.

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Past performance is no guarantee of future results. Investments are subject to risk, and any of Kiker Wealth Management’s investment strategies may lose money. Investment return and principal value of an investment will fluctuate so that an investor’s portfolio may be worth more or less than their original investment.

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