Insights from the Observatory

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What an extraordinary time this is! During times like these, I long for the ordinary again, but what is ordinary any longer? Since I started in this business in the mid-90s, I have seen a dot com bust, the worst terrorist attack on U. S. soil in history, the Great Financial Crisis, and now a global pandemic that has put the brakes on what was one of the longest U.S. economic expansions of all time. Some of you have a much deeper remembrance of history, including the inflationary period of the early 80s or the oil embargo days of the early 70s.

Despite all these significant events, the stock markets have managed to break through at some point and reach new highs each time. So, if I’ve learned one thing, it’s that you can’t have ordinary without extraordinary.

Most of our clients have been through an Observatory session (formerly known as the Cashflow Fingerprint), a proprietary process we use to recommend your financial plan. (If you have not, please call the office today and schedule one with your Advisor.) The reason this modeling is so critical to your financial success is that it considers all the shocks the stock market has experienced over the past 90 years. One of our firm’s founders, Andy Shaul, likes to call Observatory recommendations irrefutable because the stock market returns we model for clients actually occurred. That’s also why I like to tell clients that returns like we are currently seeing have all been baked into their planning. We all worry about what the stock market is going to do and how it will affect our lives. That’s where the power of the Observatory model is so helpful.

A Look Inside the Numbers

When we take clients through an Observatory session, we are typically looking at long-range results of 20-, 30-, or even up to 50-year periods, depending on a person’s age. Given a client’s current lifestyle, we get a success ratio over a set time period, determined by whether a client runs out of savings before the end of the modeled period.

What clients do not often see is the underlying data that supplies the pass/fail results. No one should base their financial planning on a single year of data, but if we look deeper at the findings used in the Observatory model, there are some interesting insights. For example, let us more closely examine the results for three different portfolio allocations. If you review 12-month periods, on a rolling quarterly basis, from 1932 to 2019, you find the following:  

  1. A portfolio of 60% stocks and 40% bonds lost money 71 out of 349 periods. The most significant loss is -32.27%. The portfolio lost 10% or more 14 times. 
  2. A portfolio of 80% stocks and 20% bonds lost money 79 out of 349 periods. The most significant loss is -43.88%. The portfolio lost 10% or more 21 times. 
  3. A portfolio that is 95% stocks and 5% bonds lost money 85 out of 349 periods. The most significant loss is -52.58%. The portfolio lost 10% or more 31 times. 

 You can see those significant drawdowns are considered when it comes to your plans. This does not mean that we cannot see anything worse than we already have in the future. It means we are planning for the worst we have already seen.

However, it is not just the severity of a downturn that is the main culprit when it comes to failure in our planning model. Coupling a severe decline with an extended duration is more troubling. We tend to see a lot of our worst-case scenarios for clients that occur during the 1937 to 1941 time period. All of the worst 12-month periods in the scenarios above are from the 12 months of April 1936 to March 1937. If we examine a 95% stock/5% bond portfolio, this is the return series we see during that time period (these are 12-month returns ending on the date shown): 

The second worst historical time span is the Great Financial Crisis, but there are fewer negative 12-month periods during that time frame: 

As you can see, negative 12-month returns are numerous and extend from beginning to end from the 1937-1941 time period, while the negative returns during the 2006-2010 time period are less numerous and are condensed to a shorter period. So, we must be careful not to get too caught up in the severity of the stock market downturns; the duration is also critically important to watch.

What Matters Most?

The reality is this data does not do us any good if we do not work within the parameters set forth by the planning model. Spending is the most crucial input of the Observatory model.

Think of the model giving us a “habitable zone” for your spending. Like the earth’s orbit around the sun allows for life on our planet, your spending needs to be within the zone dictated by the model to allow you the lifestyle you desire. Spending outside the zone can lead to an unsustainable lifestyle.

The repetitive nature of the modeling process also has a significant impact on success. You should be performing this exercise annually. Doing it once and expecting the results to be valid in five years is unhelpful. With each passing day, we know more about ourselves, the returns we have achieved, and how much money we have spent. One Observatory session is just a snapshot of your financial life as it currently stands. Annual evaluations allow you to identify how well you did since the last meeting, and what changes may need to be made to ensure success going forward.

We do our best to make sure your portfolio is reviewed at least once a year. In addition, we encourage you to schedule an Observatory session if you have experienced any life-changing events. Job loss, job promotion, marriage, and the birth of a child are just a few of the reasons you may want to sit down with your Advisor and review.

But if you have questions or concerns about your financial plan and its performance, there’s no need to wait until your next scheduled session. Just pick up the phone, call your Advisor, and schedule a meeting.

We are grateful for your trust and eager to answer any questions you might have.  

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