Will You Be OK If Stocks Stumble?

Welcome to "The Informed Investor," where we break down the latest financial headlines, bringing in research and insights to help you separate the news from the noise. Happy New Year, everybody. I hope you had a awesome holiday season with your friends and family, a chance to recharge, rest up a little bit. And thank you for tuning into "The Informative Investor." It is a show brought to you by Dimensional Fund Advisors, who is bringing financial science to investing. Now, today's topic is about the fire drill. How do we prepare for the unexpected when it comes to our investments? I'm Mark Gochnour. I'll be joined today by Wes Krell and Jake DeKinder. And guys, let me start with the headline and Jake, then I'm gonna come to you because this was your idea. I'm ready. I'm ready. This idea of a fire drill, so, Well, technically, it wasn't my idea, but I am excited for this episode. You invented the fire drill? I knew it. I did. Man, I'd be so rich. Yeah. This episode is your idea. Okay, so let me start out with the headline here. "The Astonishing Bull Market Will End One Day. Are You Ready?" And Jake, that kinda gets back to the idea of the fire drill. You gotta get ready for some of these unexpected things that may come our way. Markets have been on a nice run. I mean, whether you look over the last couple of years, you look over the last five years, you look over the last 10 years, I mean it's been a strong period in markets. And I think people lose sight when things are good that it's probably not always going to be smooth sailing in markets. And that's the concept of the fire drill, right? You don't go through the fire drill when the building's on fire. If you get on a boat, they don't show you where the lifeboat is when the boat's going down, right? You're prepared for when things get bad. And that's why I think coming into this new year, it's a good time to set expectations that you gotta be prepared for volatility. And we talked about these astonishing returns in the headlines. But if you go back the last five years through November, the S&P's up right around 15% or so. So an incredible five year- Great run. Just Movement of the market- The frequency of good returns, I mean you got four outta the last five calendar years have been at least 18%. You know, with 2022 disappointing year thrown in. And so, I think when you're on that kind of hot streak for markets, you know, people might have a tendency to think, "Well, this is gonna continue." But historically, that's not been the case. Mm-hmm. Well, it's a great topic, Jake. Again, you get into these time periods, you don't want to panic, right? You have a plan. You wanna execute on the plan. So as we think about some of the markets and setting expectations, Wes, how do we think about some of these time periods, which inevitably will come our way? From an academic perspective, how do we think about some of these tough times? Well, they talk about an equity premium being a risk premium for a reason, right? Because there's no guarantee over any time horizon that you're gonna get a positive outcome from this. I don't care if you live as long as Yoda for 900 years, invest that whole time, there's a non-zero probability that you're going to get a negative outcome from equity markets. Now we do know, at least historically speaking, the longer you're invested, the lower the probability of or the lower the frequency, I should say, of getting a negative outcome. But that just suggests that we need to be prepared for if we get a disappointing run of returns. And you know, one of my favorite misconceptions that stocks are less risky in the long run. You know, we know that okay, even though the frequency of a positive outcome increases over time, the actual range of outcomes for growth of wealth is vast when you get to 10, 15, 20 years. Yeah, it's an interesting way to think about it, right? 'Cause we do sort of say, "Oh, take the long-term approach. Take the long-term approach." But when you think about it in terms of a cone of outcomes, there's a lot of variability in the stock market and you've gotta be prepared for that. And there's so many examples through time of long runs where the unexpected took place. I was just thinking about that. You know, we talked about you got a bunch of numbers there looking at statistics and things like that. But Jake, we like to say just, "Hey, you know, about one in four years, you're gonna have a negative run in the market." And we've seen that the last five years. You know, we mentioned that 15% annualized return. I think it was 2022 where we had a really rough year in the market, but the other four years were really strong returns in the market. Well, and 2022 is a great example as well. And I mean if you remember back to it, you not only had stocks that were down, but you also had bonds that were down. And I think that surprised a lot of people. Sort of the classic argument is that well your bonds are gonna hold up when your stocks may be down. That's not always the case. Look at 2022, like this type of stuff happens when you are an investor and you've got to be prepared for it. Yeah, even when I think about US stocks, and I think sometimes people think, "Well, the US market's different, you know. It's been on a great run. This could continue." I'm sure a lot of those people were saying the same thing if they were around back in 1989 about Japan. Remember where, you know, that was probably a similar level of confidence, where they had a very strong economy, a lot of growth there. They had pretty good stock market returns. And what did we see from there? Well, they go almost 29 years without setting a new high. So, I think that's not saying that that's gonna definitely happen to the US, but that is always on the table. That one particular country stock market could go through a barren decade or longer. I think we've cited that before too. If you go back to end of 1989, I mean Japan was larger in terms of the market cap compared to the US, and then you hit this massive run. So, where are we with the US right now, right? By far the largest country that's out there. And to Wes' point, we're not making the argument that we expect the US to fall off a cliff. But there's a possibility that 10 years from now, US could have really bad returns and be a much smaller percentage. There's also the other side of it, where it could keep smoking it and it could keep on its run. You just don't know. You just wanna be prepared for both. You wanna be prepared for both. Remember, we talked about the lost decade, where- Completely. It was, what, minus 0.9% over that 10 years and that could happen again. Or you know, we talked about Japan with people and sometimes, we'll mention those numbers and they kinda look at us like, "Yeah, but that's not gonna happen in the US." And potentially it could happen, right? And I think that's the thing there, it's possible. Yeah, we've, you know, I think we've talked about global diversification in the past, but when we look across countries' equity markets, I think it was all but seven of the countries we have data for. I believe it was 45 countries all, but seven had had at least one 10-year period with a negative outcome for stocks. So you know, that's now it sets up the question of what do you do. That's the point of a fire drill is what would be your preparation. Of course, all the things we talk about diversification. The Japan example, you know, you go through that almost 29-years stretch of time. Japanese small cap value stocks returned over 450%. So, there are bright spots in markets, which is why, you know, you want to be diversified across different asset classes 'cause we don't know which ones can turn in a really disappointing decade. I mean I love, that's a great way to think about it and I think we've said it many times in the show of, so what are you gonna do about it, right? This episode is not to say run from equity markets or be freaked out, right? It's to say just be prepared and take the steps that you can to ensure that when those types of runs happen, when you get some unexpected outcomes, you've done everything possible, right? And that's the concept of the fire drill, right? Like you've prepared for it. You know where the exits are. You know where a fire extinguisher is. You know where the ladder is. I mean if you live in California, right, like there's a good probability that an earthquake will likely come at some point. It doesn't mean you live in fear. It means you're prepared for it. Yep, absolutely. And part of that is when it comes to markets, setting proper expectations about what we've seen historically and how do you learn from that. And one of the things I always love to think about is the distribution of returns we've seen over time. So if you go back the last 99 years, and Jake, we talk about this a lot. Like okay, what's the expected return on the market any given time period? I'm gonna say about 10%. About 10%, that's what we've seen historically. Yet if you look on a calendar year basis over the last 99 years, only six of those years fell somewhere between eight and 12%. So, I always like to say, "So, what's an average year in the market?" Well, on expectation it's 10% just because that's our long run return there. But what we see in real life, somewhere out here on the edge is really, really strong returns above 10% or perhaps really negative returns somewhere below zero. To me, that's more of an average year is out here. Not necessarily right around that 10%. I think that's, again, we're just, you are mentally preparing yourself for. You look at all of the data. You form the best expectations possible. You put together a good plan. It's just as an investor, expect the unexpected. You know, we cited some of those numbers as well. There's a more recent one as well. You can go from 2000 through 2020, so a 21-year period, where long-term government bonds beat the S&P 500. I mean, we just went through one of these, right? These sort of unexpected outcomes pop up on maybe a more regular basis than you might think. Yeah, it's also good opportunity when you're going through this drill to think about your investment goals. Like what are your needs and things that you're trying to plan for and think about, okay, is this consistent with the level of risk that I'm getting in equity markets? You know, for example, if you were saving up for a house, you have, you know, a sum of money for down payment. If you need that money in the near future, well then maybe you don't have as much exposure to stocks. Because again, when we look at the data, there is a possibility of having a large decline in a short period of time with stocks. And so, I think going through that whole exercise for financial planning can be helpful. Agree with that. Well, I think built into that plan too is having some challenging years. You know, that's going to happen at some point. You just don't know when. So, it goes back to your point about having a buffer there, whether it's cash or whatever your short term needs are. And I think if financial professional helps in a significant way, you know, helping people think through their plan and what their needs are going to be going forward there. Just like we always have the fire warden here to help with our fire drills, you know? If we were doing it ourselves, we wouldn't be as adequately prepared for a eventual fire. I feel like sometimes, we're a little bit behind on time though, you know. I feel like they're always like, "Oh, you missed it by 30 seconds." Well, really, I thought I was just hustling- Yeah, well- As hard as I get outta the building. You used to give us treats at the end like either ice cream or cookies if we get out in three minutes, but we haven't done that in a long time so. That's why we have to keep doing it, but we can- That's right. Get it right. Get it right- Practice makes perfect. Yeah, that's right. All right, I'm gonna read another headline here, which sets up to ultimately what we're getting at with having expectations and doing the fire drills. So, here's a way to summarize some of the conversation. "The Most Dangerous Threat to Your Money May Not be a Market Crash. It's much more personal." And I think that gets into the emotions of when we do get into tough time periods, do you panic or to resort to your plan? And so, I'm gonna give a number, and then I'll let you guys weigh in on get a reaction to this. So, this goes back to the financial crisis 2008, 2009. GFC, some people call it, the global financial crisis. I've heard of the great financial crisis as well. But it was a tough time period because it wasn't just from a US investor perspective, the US markets were down. I mean markets were down about 50% all around the world. And if you look at the cash flows in mutual funds during that time period, 2008 to 2012, there was about $536 billion being pulled out of mutual funds at that time period. So part of that, you're seeing the discipline breakdown people, saying, "I can't take it. I'm outta the market." And that's really what we're talking about here in this episode. I mean that's what, again, it comes down to the point that Wes made, which is what are you gonna do about it, right? What are you gonna do about it ahead of time so you can be prepared. But then when you're in the moment, what are you gonna do about it? And the reality is look, you can get long runs or a specific asset class. I'm gonna say US stocks or Japanese stocks can go on some really some really long runs, but more often than not in a diversified portfolio, we have seen sticking to the game plan, capturing those long run capital markets rates of return is probably a better approach than trying to say, "I'm concerned. I'm bailing on markets and I'm just gonna wait for things to look a little bit better." 'Cause the hard part about that is that we know markets turn on a dime. Again, go back to March of 2020, right? Bottom of the market, news looks awful. People are freaking out and things just turn on a dime and you don't wanna be sitting on the sidelines when markets go on those runs. Yeah, that was another example of where we just saw so many flows going into money market funds in March of 2020. And then, you know, I was actually, we were joking earlier, I forgot how good the turnaround was in 2020 and how the S&P 500 ended up over 18% for the year. And you kind of wonder how many of those people who flocked in the money market funds missed out on the rebound. And that's kind of the nature of investing is you want to be there for the long term if you don't know when those returns are gonna show up. I was down. I was down in Houston mid-December, chatting with advisors just talking about sort of these concepts, literally having them, how do we get ready to have these conversations with our clients when we hit January. And they brought up an example of a client that just couldn't take it in March of 2020 and got out and they said the line of, and they're still waiting to get back in. Yeah, okay. And they're still waiting for the pullback, you know? Yeah. And that's the hard part is that when you miss out, you're like, "Oh, I'm just going to wait." Man, a lot of times you're gonna be sitting on the sidelines for a long period of time. Well just think about that they missed, there are still on the sidelines over the last five years and missed out on that annualized 1%. We've seen here in the US. Come on. Man, that's a tough one to overcome there. Yep. Hey, you know we talked about some of that money that goes into money market accounts or the flows we just talked about out of mutual funds back in the the GFC. Sometimes, we do get the question though. Yeah, but somebody has to be on the other side of those trades, right? So, somebody's selling and going to cash. Somebody else must be buying it. And we don't know exactly who that is buying. It might be people that do have a plan that are rebalancing into and buying more equities maybe at some institutions. We're not exactly sure who is there, but we do know some of that is retail money where people are, you know, panicking the motions, get the best of them, we're going to cash. Well, there's always somebody on the other side of the trade. And I think what you find more often than not is sort of disciplined investors that stick to the plan, that do the rebalance, especially on the wealth management side. I mean, how many stories did we hear during that period of advisors executing the plans for clients, which was we are going to buy more stocks, because we're supposed to rebalance, because we're gonna stick to the plans. So, there are other people on the side of that making that trade. Yeah, I mean that's why prices move, right? If you have a disappointing news, you get a decline in market prices because investors aren't willing to sign up for stocks at the same price today as they did yesterday. But that also means that whatever the concerning news was, it might have driven down the market that's already reflected market prices at this point. Now, could you have a continued, you know, rash of bad news? It's possible, but whatever we were reacting to in that moment is now already incorporated in prices and so, it doesn't mean we're gonna have a bad return going forward. I think that's one of the challenges with market timing is people are reacting to stuff that has already moved market prices and it's not useful going forward. And you also get the classic line, which is, "It's different this time." I mean, how many times we've heard that, right? And we heard it back in March of 2020, right? Like it's different this time and yeah, it is. I mean, none of us really, were expecting maybe a global pandemic and these things to happen. But again, when you think about the fire drill concept, like be ready for that. We're going to encounter, there's a high probability we're gonna encounter something that's going to be different as human beings on this earth. There's a chance that that's gonna affect market prices. So when you get in that moment and you make the argument in your head of it's different this time, push yourself to say, "Yeah, but should I do something different?" But Jake, you made a good point earlier when we were talking today where you said, "Hey, we need, we're in these good times." And you just want that expectations to be ready when challenging times come. But it goes the other way too, as you were saying that. Hey, when you're in the really tough times and markets have dropped a lot, you wanna be prepared for the good times too. Meaning don't go to cash, like we're just talking about stick to year plans. So when those returns come and they come unexpectedly, you're there to get those returns. It's a mental, I think it's almost a goal as an investor where you're getting mentally and emotionally prepared for there's going to be volatility, there's going to be events. When things are really good, it's not always gonna be good. And by the way, when things get choppy and markets go down, they could keep going down. That is a possibility. We know that. But also prepare yourself that what we've seen is more often than not, when you ride it out, markets do tend to benefit those that can stick it out. Tough times don't last, but tough investors do. Dang. That's fantastic. Fantastic, you should get that on a shirt, yeah. Yeah. Per slogan- You gotta stay it with more gusto. Yeah, well, you know, I'm very enthusiastic about it. So yeah, we should print it on some business cards. He had a late night over the new year. What are you gonna do about it? Well, he's not the only one I'm sure- I was thinking about the podcast all New Year's Eve. Yeah, you are. Great line though. Great way to wrap it up here, so well done Wes on that. And listen everybody, thank you for joining in here today. Appreciate your time and our next episode, you know, we'd love to look at headlines here. We are gonna look at a lot of the headlines we've seen as we wrapped up 2025. Things we're reading about as we go into 2026, so we're gonna dive into some of those headlines and just think about that as an investor going forward. The other thing I wanna highlight is be sure to check out the show notes. We are launching a survey for two reasons. One, we wanna get feedback from all of you, what are you enjoying about the show, but most importantly, what are some of the things we could do differently for all of you out there that are tuning in. And secondly, if there's any topics you'd like us to address, it's a chance for you to put those topics in and we will bring them into the conversation. So, thanks for joining us today. Have a fantastic rest of the day.