Financial & Estate Planning

Practical Finance: Thinking About Hurricanes (and Bear Markets)

PRACTICAL FINANCE…

THINKING ABOUT HURRICANES (AND BEAR MARKETS)

Having our headquarters on the gulf coast of southeast Texas, most of us at Linscomb & Williams are plenty familiar with how it feels to live in an area that is threatened with a significant hurricane about once every 10 years. Some in our L&W family are familiar in a completely personal way with these risks, having been flooded out of their homes in Hurricane Harvey.

Despite our personal memory of experiencing these risks, none of our L&W family has decided to sell their home and move away from Houston. We got into some discussion about this during a recent staff luncheon and attempted to answer the question: Why? Why stay in Houston despite knowing that it is not a question of “if” but “when” the next significant hurricane will impact our area?

A few common answers came out of that luncheon conversation:

  • “The risk is worth the award. 99% of the time you have a nice house in a nice location close to some of the greatest people in the country.”
  • “If you were born here, you are just used to it.”
  • “I could live somewhere else and face earthquakes or wild fires. Hurricane threats are a small price to pay to live in a place like Houston with a great economy.”

Maybe this is instructive in framing how we should think about the possible impact of a bear market on our portfolios. A bear market decline in the stock market is the financial equivalent of a hurricane.

The odds of facing a bear market if you are an investor in stocks is similar to your risk of living through a hurricane in Houston. There is no “if”, just “when”. You are likely to see one about every 10 years. A bear market in stocks (a decline of 20% or more) may well do some damage to your portfolio in the short term, but history shows that you will likely recover.

Bear markets are part and parcel of the risk of being an investor in the stock market. And the rewards in the long-term from being invested in quality stocks are well worth planning for this risk. Compared to the returns likely from more conservative investments (bonds or cash), your long-term returns on stocks will probably outpace inflation.

You plan for the risks of a hurricane by doing sensible things like building your home on a solid foundation above the flood plain, owning a back-up generator, and stocking up with emergency food and water supplies. Smart stock market investors make sure they own the stocks of high quality companies that will bounce back when the storm passes. They generally have enough diversification in their asset allocation to ensure that everything they own is not down in price at the same time. They keep enough emergency cash on hand to ensure they are not forced to sell their stocks at the wrong time.

We’ve observed that bear markets seem most fearful to newly-retired investors who are unaccustomed in their new chapter of life (no regular paycheck) to observing a decline in portfolio value. For the same reason we in Houston are more fearful about earthquakes if we move to Los Angeles, the new retiree fears the bear market because he or she has not lived through one to enjoy the recovery on the other side.

“If you want to see the sunshine, you have to weather the storm.” – Author Frank