EyeWorld is the official news magazine of the American Society of Cataract & Refractive Surgery.
Issue link: https://digital.eyeworld.org/i/511377
OPHTHALMOLOGY BUSINESS 66 May 2015 by Mitch Levin, MD, CWPP, CAPP Volatility is not risk ly and amazingly, years between 30% and 40% up are more common than years with around 5–10% posi- tive returns. How much time does it take for the 20% upward run? It usually takes 3 months or less. Moreover, the average intra-year decline since World War II has been 14%. That means that within a given year, you can expect a 14% decline in the short-term pricing of the stock mar- ket. Yet a bear market is described as a decline of 20%. The so-called once-in-a-100-year storm of a 50% decline has actually happened more than 3 times in the last 100 years. For those who were able to invest and stay fully invested for that 100-year period of time, you have been rewarded with an increase in the S&P 500 from approximately 15 to approximately 2,000. That's a more than 100-fold increase. Certainly we would take a 100-fold increase with occasional short-term declines. Of course, few of us will get to enjoy 100 years of investing. Most of us will experience 20 or 30 years. Of course, we have a lot of eco- nomic risk now: low employment participation, low interest rates, high debt, many new regulations, geopo- litical instability, and more. If you have heard, "We have never been here before," I encourage you to recall another time we faced similar issues—specifically 1947, with prime interest rates of only 1.75% (now it is 3.25%), Communist China, newly returned GIs, a war to pay for, the New Deal, and so on. What happened? A giant, long-term bull market in stocks is what happened. I am not predicting another. I am not predicting any- thing. I am merely helping you put your point of view into perspective. Things are not "different this time" because things are never quite differ- ent. EW term. Charlie Munger, Berkshire Hathaway, Omaha, Neb., said, "If you're not willing to react with equanimity to a market decline of 50% two or three times a century, you are not fit to become a co - mon shareholder and you deserve the mediocre results you're going to get, compared to the people who do have the temperament to be more philosophical about market fluctu - tions." Of course, by this he assumes you are "over" invested in stocks. You are not. Very few are. Even few- er should be. So if longevity is not a risk, and purchasing power is not a risk, and investment portfolio value fluct - ations are not a risk, what are the risks? The primary risks could be investor behavior and not having a comprehensive, collaborative plan. The risk matrix illustrates widely known and practiced assessment and management strategies. Each quadrant represents a response or behavior to risk based on its level of severity and probability. We can transfer risk, accept risk, avoid risk, and manage risk. Now that we've covered risk, let's consider volatility (which is not risk) in the market. The "markets" tend to surprise to the extreme, making volatility a dual-edged sword. Investors don't feel the up years as volatile because we enjoy them. Volatility it is nevertheless. Average returns aren't normal at all. In fact, normal returns are extreme. They occur infrequently. Only when the high and low returns are blended do we get the average. Some investors may expect average, but we rarely get it. In all calendar years since 1926, U.S. large company stocks (or "the market") have been down 27% of those years. So the market has been up 73% of the time. And the market has risen by more than 20% in more than half of those positive years (or 36% of all years). That is, 1 out of every 3 years, the market has gone up by greater than 20%. Moreover, for the past 65 years, the market has reached a "new high" 1,100 times, or once every 15 days. So when the market hits that next new high, should you sell? In other words, if we don't get a down year, history favors large upside. Years with positive returns of around 5–10% (what most people usually expect as average) only hap- pen 1 out of 6 years. More frequent- H ave you heard the old joke that economists have predicted 9 of the last 2 recessions? And have you ever wondered why it makes the news when something bad happens—whether it is war, swindling, or crash of the economy? It's because those are uncommon events and because "if it bleeds, it leads." Now the headlines are some- thing like "The markets are due to tumble" or some other risk. Risk has 2 major components: severity and probability. When you put them on 2 axes, many of us focus only on the severity of the risk and too many of us forget the probability of that risk. Severity of investment risk is that prices tempo- rarily decline by about 50%. Probability of the risk of a large decline occurs every 30 years. Since 1926, the average time for a major market top through the subsequent bear market and back to full recov- ery is about 40 months (3.3 years). So if you begin retirement with 3 years' living expenses in cash equiv- alents, you have covered the great preponderance of possible historical outcomes to safeguard that risk and to further enhance your returns within your tolerance for risk. When looking at risk, we must define whether this is a problem or a fact of life. If it is a problem, by definition, it has a solution. If there is no solution, it is a fact of life. Facts of life are not risks. Risks are problems. Many facts of life may or may not present risk. Is there such a thing as longevity risk? I don't think so. It is not a risk at all. It is a simple fact of life. We know there is a greater than 60% chance that for a couple aged 62 right now, at least 1 of them will live well into their 90s. That to me is not a risk. That is a fact of life. True risk is not planning that your assets and income carry you into your 90s and even beyond. What about investment risk? Is there such a thing? It is a phenom- enon, a fact that in a properly con- structed portfolio, held for the long term, has no basis in reality. What about purchasing power risk? That is also an eternal fact of life. A properly constructed invest- ment portfolio will be able to withstand the risks over the long Dr. Levin is CEO and managing director of Summit Wealth Partners, Orlando, Fla. He can be contacted at MLevin@ mysummitwealth.com. About the author The risk matrix