We’re only a few weeks away from New Year’s Eve, and you know what that means: it’s resolution time. Exercising more, eating healthier, losing weight, and spending more time with family. These are among the most popular resolutions, each and every year.
In the investing world, instead of resolutions at year end we often hear forecasts. Where the S&P 500 is headed, what the Federal Reserve will do, and the fate of the US economy.
All of these things garner a lot of attention, but investors would be wise to ignore them.
Why?
Because they are rarely correct, as we learn year in and year out.
A year ago, Wall Street strategists were predicting a 7.5% return for the S&P 500 in 2022 with S&P 500 earnings growth of 7.9% (45 strategists polled by Reuters).
And what actually transpired?
As of this writing, the S&P 500 is down 18.3% year-to-date, on pace for its worst year since 2008. And earnings are down 11% year-over-year through the third quarter.
Why is predicting what will happen in a year so difficult?
Because markets are forward looking and driven by a multitude of factors, the most important of which is investor sentiment. Which means that even if you knew what was going to happen with one of those factors (let’s say the economy or earnings), you couldn’t say for sure what the reaction would be.
2020 was the perfect example of this, as US real GDP and S&P 500 earnings fell while stock prices surged higher. No one would have predicted this confluence of events, which is precisely the point.
As the forecasts for 2023 pour in, it’s your job as an investor to ignore them. What should you focus on instead? Here are a few resolutions to consider, not just for 2023, but for life…
1) Embrace Risk
Risk often has a negative connotation, but you can’t ignore the major positive: without it, there would be no reward. That concept applies to many aspects of life, and most certainly to investing.
If you’re a long-term investor, some amount of risk needs to be embraced if you want to earn a return higher than cash.
In years like 2022, when stocks and bonds are falling together, it’s tempting to shun all risk.
But in the long run, not taking enough risk can be the biggest risk of all, as your purchasing will be eroded from the constant drumbeat of inflation. Embrace risk.
2) Play the Long Game
The media is obsessed with what’s happening today, but as a long-term investor the day-to-day market movements are just noise, and not the game you want be playing. Your biggest asset is time, and learning to use that asset to your advantage will make all the difference.
The odds of a positive return in any given trading day is barely higher than a coin flip, but as you extend your horizon, you can be more and more confidence in achieving a positive outcome.
The big money in investing is made not in the short-term wiggles but in the big moves. The longer your holding period, the higher your prospective returns. Play the long game.
3) Diversify, Diversify, Diversify
If you could predict the future, you would pick only the best performing asset classes.
Over the last decade that would have meant a portfolio concentrated only in U.S. large cap growth equities, as evidenced by…
- large cap US stocks outperforming their global peers by a wide margin,
- growth stocks outperforming value,
- large caps outperforming small caps, and
- constant beta outperforming alternatives.
But since no one can predict the future, you probably didn’t own a portfolio of only large cap U.S. growth equities. And that’s ok, because real diversification means that not everything in your portfolio will be “working” at the same time.
There’s a cycle to everything, and in 2022 we’re seeing the benefits of owning things (value, alternatives, etc.) that were previously out of favor.
In the world of fixed income, we’ve witnessed the same, with diversification in terms of lower duration (Treasury Bills) and credit (Leveraged Loans) proving their worth.
Will 2023 be a repeat of 2022?
Not likely. The leaders and laggards in markets are forever changing, and the best protection against our inability to predict them is to Diversify, Diversify, Diversify.
4) Focus on What You Can Control
As a diversified investor, you have no ability to control the timing or magnitude of returns. Put simply: they will be what they will be.
What can you control?
Your habits and your behavior.
On the habits side, that means simple things like living within your means, trying to save more when possible, and following a regimented investment plan.
On the behavioral side, that means not succumbing to the two most pernicious emotions: fear and greed. These two emotions drive us to sell low and buy high, again and again. As a consequence, investor returns tend to trail fund returns by a sizable margin, known as the “behavior gap.”
Every year has drawdowns. In some years they are much larger than others, but the one constant is risk. When markets are going down, fear can take over, inducing you to act (sell). If you can push back against that fear and hold on, you’ll earn the market return and come out ahead of most investors.
Greed hasn’t been a big factor in 2022, but you can be sure it will be back again at some point in the future. And when it does, be prepared for a different kind of fear: missing out. As we’ve seen with countless examples over the past two years, acting on FOMO in the midst of a mania often leads to disastrous outcomes.
Focus on what you can control: your habits and your emotions.
My Only 2023 Prediction
In 2023, I predict one thing and one thing only: you will see many more surprises. That is the nature of markets. As to what the surprises will be, leave that guessing game to the pundits. Stay focused on your resolutions and stick to your plan.
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Disclaimer: All information provided is for educational purposes only and does not constitute investment, legal or tax advice, or an offer to buy or sell any security. For our full disclosures, click here.
