From Emerald Retirement

Dear Clients,

One of the most important truths about investing also happens to be one of the easiest to forget: growth doesn’t happen in a straight line. We know this intellectually—we may even nod along whenever someone reminds us of it—but emotionally, when prices are moving lower and the news is loud, the linear-growth fantasy reasserts itself, and we begin to think that something must have gone terribly wrong. That, of course, is precisely the moment when the discipline of planning matters most, and in this letter we want to revisit why we plan the way we do.

Markets do rise over time, and they have done so reliably enough, over long enough periods, that we can confidently build a financial plan around the expectation. But they do not move upward smoothly. Along the way there will be dips—sometimes small, sometimes uncomfortable, and occasionally significant. These temporary declines aren’t a sign that something is broken. They are simply part of how the long-term ownership of equity behaves, and they are, in fact, the very reason that owning equity has consistently produced returns superior to those available from less volatile asset classes. We are paid to ride out the bumps. The premium that long-term equity owners earn over bondholders—what is commonly called the “equity premium”—exists precisely because most people aren’t able, or willing, to sit still through them.

We cannot tell you with any precision when the next decline will arrive, how deep it will go, how long it will last, or what particular headline will be blamed for causing it. We are, however, in good company: nobody else can do it any better. The most reliable economists, the loudest market commentators, the algorithm-driven hedge funds—none of them can consistently predict short-term market movements with anything resembling accuracy. If they could, they wouldn’t be selling subscriptions; they’d be vacationing.

What does work, and what is in fact our entire game plan together, is preparation rather than prediction. We don’t need to know when downturns will arrive in order to be ready for them. We just need to be properly diversified, properly reserved, and properly disciplined when they do. Three pieces, working together:

The Role of Diversification

When we refer to diversification we are not talking about owning a few different stocks, or even a handful of mutual funds. We are referring to what we have always called a globally diversified equity portfolio—a deliberate ownership of many segments of the world’s productive economy, in a balanced and systematic way. Large companies and small. Domestic and international. Dividend-paying value and growth. Because we can never know in advance which segment will outperform in any given short period, we eliminate the need to know by owning them all. The pieces don’t all move together; their imperfect correlation is what produces the smoother ride that a well-diversified portfolio delivers over time. When one corner of the world is struggling, another is often holding steady, or even leading the way.

The Role of Reserves

Diversification alone is not the whole story, particularly for clients who are at or near retirement. The second piece of the architecture is reserves: assets we hold deliberately apart from your equity portfolio, set aside not to chase returns but to give us flexibility. In the years leading up to and following the start of your distribution phase—what financial planners refer to as “sequence of returns risk”—the very worst thing that can happen is being forced to sell equities at a loss simply to cover ordinary expenses. Reserves exist so that we are never put in that position. When markets are down, we draw from the reserve. When markets are up, we replenish. This single piece of the plan eliminates the most damaging behavioral error a retiree can make, which is to convert a temporary decline into a permanent loss because the bills had to be paid.

The Role of Rebalancing

Finally, there is rebalancing—and this is where systematic discipline does the work that emotion would otherwise undermine. Over time, the various pieces of your portfolio drift apart in value as some grow faster than others. Rebalancing is the simple, periodic act of trimming what has grown beyond its target and adding to what has lagged—a discipline that is, in effect, the formal practice of selling high and buying low. Done emotionally, it is nearly impossible. Done systematically, it is one of the most reliable contributors to long-term outcomes that we have. It also happens to be one of the few things in investing that nobody has to talk you into; the schedule and the targets do the work.

So that is the approach, in three pieces: we participate in growth when it is there to be had, we use diversification to soften the inevitable bumps, and we hold reserves so that those bumps never derail your plan. The point is not to avoid volatility—volatility cannot be avoided, and as we noted earlier, it is in many ways the very source of our long-term returns. The point is to make sure volatility doesn’t derail your plan.

Market downturns will come. That is a certainty. The cycle has always turned, and it will turn again, and again after that. But this is also true: when the next one arrives, you will already be prepared for it, because preparation is built into the strategy from the very first conversation we ever had together. Optimism, as we are fond of reminding clients, is the only realism—and the optimism we’re referring to is not the wishful sort, but the kind that is grounded in the actual long-term behavior of human ingenuity and of the great companies that channel it.