The first six months of 2024 can be distilled into two key observations:

• Modest Economic Growth: The U.S. economy has continued to grow, albeit at a measured pace.
• Strong Equity Market Performance: The equity market has delivered impressive gains, driven by earnings growth and rising dividends.

We have seen steady economic growth, avoiding the feared recession, and job growth has held firm. Inflation has begun to ease, allowing the Federal Reserve to hold off on immediate rate cuts, although some are expected later this year. The Fed remains committed to its 2% inflation target.

Even with record-high cash dividends, large U.S. companies are paying out a smaller share of their earnings—about 37%—compared to the 30-year average of nearly 46%. This signals substantial potential for further dividend growth in the coming years.

Ultimately, the long-term value of our core investments—ownership in a diversified portfolio of successful companies—hinges on earnings and dividends. While external factors like national debt, elections, or geopolitical events can make headlines, the true drivers of value are the fundamental performances of the companies we invest in.

Since the close of the second quarter, we have seen the stock market go through one of its periodic bouts of volatility, almost dipping into correction territory after peaking on July 16th. A correction is typically defined as a decline of 10% or more from a recent high. While often unsettling, these events are hardly unusual—they happen roughly once a year. Our investment strategy, grounded in the principles of long-term value creation, is built to withstand these inevitable fluctuations.

Historically, the average intra-year decline—the drop from the highest point to the lowest during any calendar year—has been 14.2% since 1980, reminding us that volatility is the price we pay for long-term gains.

While it's possible that this correction could deepen into a bear market (defined as a 20% decline or more from the peak), predicting the extent of a decline is a fool's errand. Historically, bear markets have occurred about every four years since World War II, with the last one ending in October 2022.

No matter what happens next, our long-term equity plan has proven its worth time and again. Here are the bedrock principles that guide our approach:

1. Investing for the Growth of Purchasing Power: Our focus is on investments that grow wealth over time, even if they come with perceived risks. Holding cash may feel safer, but it’s a surefire way to lose purchasing power. The best tool for growing wealth is owning a diversified portfolio of successful companies for the long term.
2. Avoiding Market Timing: Trying to outsmart the market by timing one’s entries and exits is a losing game—especially after accounting for fees and taxes. The most reliable way to harness the full power of compounding is to stay fully invested.
3. Seizing Opportunities in Market Downturns: We see market dips as opportunities, not causes for panic. Our strategy continues to work during temporary declines by reinvesting dividends and letting the power of compounding do its job. By purchasing more shares at lower prices, we amplify the powerful long-term benefits of compounding.
4. Understanding Market Fluctuations: It is crucial to recognize that temporary declines in account value are not permanent losses of capital. They only become permanent when an investor sells out of fear.
5. Rebalancing Periodically: Rebalancing involves trimming back asset classes that have grown beyond their target weight and reinvesting in those that have lagged, ensuring that your portfolio remains aligned with your long-term goals.

It is natural to feel a bit on edge during an election year, with the usual mix of rhetoric and alarmism dominating headlines. With significant global tensions and nearly half the world’s population heading to the polls this year, the noise can seem even louder. However, history tells us that election outcomes have little to no meaningful impact on your long-term investment results.

One of the most persistent myths in investing is the belief that the outcome of the next presidential election will dictate market performance. Many people make short-term decisions based on election predictions, but countless studies have shown that neither the election result nor the occupant of the White House significantly impacts the long-term direction of the stock market.

Let us keep things in perspective with three key points:

• It does not matter much who the president is.
• The broad equity market goes up most of the time, regardless.
• The best course of action is to remain invested.

The late Charlie Munger’s wisdom rings true as ever: “The first rule of compounding is never to interrupt it unnecessarily.” There is no greater unnecessary interruption than selling in anticipation of a presidential election. With election outcomes and the events of the next hundred days uncertain, our course remains clear:

None of this should concern lifetime investors. The strategy that has always worked is to follow a consistent, long-term plan. Presidents and their policies will come and go, as they always have. But through it all, superior companies continue to serve their customers, grow their earnings, and increase their dividends. At its core, investment success is almost entirely a matter of behavior.

Fear of Missing Out has earned its acronym for good reason—it's a remarkably common affliction. When combined with recency bias, humans are especially prone to sabotaging their own best interests, regardless of market conditions.

The allure of recent events can amplify recency bias, where the latest news gains disproportionate importance. We might begin to believe that current market developments are more significant than the countless similar occurrences throughout the history of capital markets.

It's essential to remember that before today's tech stars like NVIDIA and AI trends, there were the prior eras of industrial innovation in the 1920s, the Nifty Fifty blue chip era of the 1970s, and the Dot-Com boom of the 1990s—each heralded as unstoppable market forces with the familiar refrain of "This time, it's different."

There's almost always something new and supposedly unprecedented that stokes investors' FOMO. However, it's crucial not to give excessive weight to recent high-flyers.

While the latest innovations can be genuinely transformative, the patterns of how capital markets integrate them into long-term returns tend to be more constant.

Regardless of market conditions—whether up or down—one principle remains consistent:

Neither hot nor cold streaks among stocks, sectors, or markets provide sufficient reason to abandon a well-built portfolio.

Long-term investors resist abandoning underperforming segments instead of chasing the hottest trends due to rational investment principles. While panic selling during a market decline poses the greatest risk of permanent capital loss, performance chasing is a close second.

Selling solid but currently out-of-favor investments to pursue popular yet potentially overvalued sectors goes against sound financial strategy. Additionally, selling appreciated assets generates capital gains tax that could otherwise be deferred indefinitely. The goal isn't just short-term outperformance; it's about steadily compounding wealth over the long run.

Furthermore, performance chasing often leads investors to narrow their portfolios to a few sectors or stocks, exposing them to increased portfolio volatility in pursuit of returns they may not necessarily need.

This lesson was underscored by Warren Buffett during a 2007 talk to MBA students at the University of Florida when discussing the collapse of Long-Term Capital Management in 1998. Buffett emphasized the importance of not risking what is essential—for example, financial security—for unnecessary gains. He stressed that incremental wealth does not significantly enhance one's life or legacy beyond a certain point compared to the risk of incurring lifestyle-changing losses. Prioritizing personal contentment over the relentless pursuit of financial gains is crucial.

It's easy to be captivated by a single hot asset or market segment and question the need for diversification. However, broad diversification is not just conservative—it's a fundamental risk-management strategy rooted in rational investing principles.

By spreading investments across various asset classes—such as small-cap stocks or international markets—we aim to buffer portfolio volatility and capture superior long-term returns

Despite the recent dominance of U.S. large-cap stocks, diversified portfolios historically offer resilience. Historical patterns suggest that sectors like small-cap or international equities may lead during certain market cycles. Patience is key, echoing Buffett's timeless advice: "The stock market is a device for transferring money from the impatient to the patient."

In long-term investing, it's important not to let recent high performers dictate your strategy. Instead, focus on your personal financial objectives. As Benjamin Graham, the renowned investor and mentor to Warren Buffett, emphasized:

"The best way to measure your investing success is not by whether you're beating the market but by whether you've put in place a financial plan and a behavioral discipline that are likely to get you where you want to go."

While hot stocks or aggressive strategies have their place, the broader strategy should prioritize sustainable, diversified growth that can navigate market cycles and ultimately achieve long-term financial goals.

Your personal financial goals should guide your investment strategy. Misguided goals can lead to unexpected consequences, as seen in the failure of Long-Term Capital Management. Establishing clear and durable financial goals early on ensures you stay on track to achieve them.

Planning for your financial future in a world of challenges and opportunities may seem daunting. However, lacking well-defined goals only adds to the complexity. Without clarity on how much money you need, when you need it, and why, you may find yourself chasing trends (buying high) or succumbing to market volatility (selling low). This not only results in financial setbacks but can also take a toll on your emotional well-being.

Reflecting on the dynamic market movements of 2023, a pivotal lesson emerges - timeless wisdom serves as the compass for making prudent decisions. Rather than getting lost in the minutiae of recent events, drawing guidance from broad historical trends proves to be more meaningful.

In his new book, “Same as Ever,” Morgan Housel encapsulates this concept eloquently:

“The typical attempt to clear up an uncertain future is to gaze further and squint harder—to forecast with more precision, more data, and more intelligence. Far more effective is to do the opposite: Look backward, and be broad. Rather than attempting to figure out little ways the future might change, study the big things the past has never avoided.”

As we delve into subsequent sections, let's explore several enduring principles illuminating our path through uncertainties and opportunities.

While not groundbreaking, the realization that the long-term upward trend has historically replaced temporary market declines aligns with the wisdom of Peter Lynch, the esteemed Wall Street guru whose Magellan Fund substantially outperformed the market for 13 years, ending in 1990 when he retired. He astutely acknowledged the inherent challenge of predicting short-term market movements:

"Far more money has been lost by investors trying to anticipate market corrections than lost in the corrections themselves."

In an ever-evolving financial landscape, this acknowledgment remains a beacon of wisdom, reminding us of the complexities and uncertainties inherent in attempting to foresee the twists and turns of the market.

Second only to love, human ingenuity stands as the most powerful force on earth. Equities uniquely embody this force, capturing the essence of human creativity and innovation within them. While these insights hold philosophical importance, the crux lies in formulating a coherent investment policy.

At the core of this philosophy is acknowledging that we, as investors, identify as long-term business owners rather than short-term speculators on stock price trends. The mainstream equity market's occasional substantial declines have consistently been overcome, underscoring the resilience of America's most successful companies through ceaseless innovation and human ingenuity.

The foundation of successful long-term investing lies in being goal-focused and plan-driven. Investment decisions must consistently align with the overarching plan and not be swayed by the transient nature of current events. Policies founded on economic or market forecasts are destined to falter in the long run.

Unaided, human nature tends to tether its investment policy to current events and trends, often making repetitive and costly mistakes, such as panicking amidst temporary market declines or succumbing to the allure of fleeting fads. Interventions by advisors committed to meticulous planning and behavior management become essential to circumvent these pitfalls.

In the annals of 2023, the spotlight was undeniably on just seven stocks within the S&P 500 Index, responsible for almost two-thirds of the index’s total annual gains. This stellar performance earned them the moniker the “Magnificent Seven.”

Fortunately, each of our clients has an allocation to the Magnificent Seven through the stock funds we use. As we peer into the upcoming year, a glance at today’s popular press reveals an abundance of timely advice on whether to increase exposure to this star lineup or seize the moment to sell. Recommendations hinge on recurring economic factors like the ebb and flow of inflation, the arrival or retreat of a recession, advancements or retractions in technology, and so forth.

While insights from financial news media and Wall Street pundits can be informative and entertaining, in reality, it is challenging, if not impossible, to predict whether celebrated stocks adorned with trendy titles will continue to outperform or are poised for a sudden correction.

The quilt chart below illustrates the randomness of returns for various asset classes over 15 years by stacking the asset classes in each column based on their annual returns from best to worst.

Our advice remains to adopt a balanced approach and maintain an allocation to growth and momentum stocks that align with your long-term goals and objectives. There will be periods when growth and momentum stocks outperform, as seen in 2023, and periods when they underperform, as observed in 2022.

This seamlessly leads us to our next timeless tenet.

Are we in for a rainy season or just a passing cloud? There seem to be two paths we can take:

Path 1: Reacting to Forecasts

Many fourth-quarter forecasts are predicting a rainy season. Following these forecasts, investors often ask speculative questions: What if the worst-case scenario becomes a reality? What if it doesn't? Which so-called "experts" are reading the market's tea leaves correctly?

Unfortunately, only hindsight can provide reliable answers to these questions, usually long after the information could have been useful for trading. This is why seasoned experts caution against getting caught up in market sentiment:

“Perhaps the thing that ‘expertise’ or 40 years of studying something really can certify is when I don’t know, but I know for sure nobody else does either! So buckle your seatbelt and brace yourself for uncertainty.”

— John Cochrane, The Grumpy Economist

“There are more ways to arrange a 52-card deck than there are atoms on Earth, which means that every time you shuffle a deck of cards, the same order of cards has probably never been seen in human history and may never be seen again.

Note to self: The global economy has many more than 52 variables.”

— Bob Seawright, The Better Letter

“I am here today to cross the swamp, not to fight all the alligators.”

— Rosamund Stone Zander, The Art of Possibility

Path 2: Focusing on Our Destination

Since none of us can predict what's around the corner, it makes sense to concentrate on matters we can control. Questions like, "Does your portfolio align with your financial goals and risk tolerance?" and "Are you adequately diversified among a sensible mix of investments?" remain essential. Additionally, consider any life changes that might require adjustments to your investment plan.

From our perspective, every twist and turn in market sentiment reinforces the importance of these questions as our best defense and offense against the market's quarterly fluctuations.

Less than a month ago, on October 13, we marked the first anniversary of the 2022 bear market low triggered by inflation. That day last year, the S&P 500 tumbled to an intraday low of 3,491.58, and the VIX, a reliable fear index, retested annual highs. As of my current writing, the S&P 500 stands at approximately 4,350.

Many people were tempted to sell that day, but our clients remained steadfast. We provided counsel emphasizing faith, patience, and discipline, advising them to stick to their plan rather than react to market fluctuations. The outcome is a testament to the wisdom of this approach: with dividends factored in, a client who was fully invested in equities may have achieved gains exceeding 25% from that day to now.

We knew our counsel was proper during those dark October days last year, even though we couldn't predict the precise path of the market's decline. The mid-term elections were just around the corner, adding to the uncertainty. Nevertheless, our principles guided us, and we were ultimately vindicated as the election uncertainties cleared.

Before we dive into the upcoming holiday season, let's take a moment to reflect on the invaluable gift we've not only received but also extended to our loved ones during these last thirteen months.

There's a temptation to think, "Phew, we dodged another bullet; let's move on." Instead, we should pause, reflect, and celebrate the power of our planning and behavioral investment philosophy, which liberates us from the treadmill of performance-based investment machinations. This is the gift we’ve been given.

Equally important, contemplate how invaluable your steadfastness is to those you love and care for. This is the gift you give.

For most investors, the ceaseless anxiety tied to performance-based investing is a constant burden. Their experiences are measured against benchmarks they can rarely outperform. They're constantly searching for economic and market forecasts, and their findings often turn out to be inaccurate. They oscillate between chasing hot trends and panicking during minor declines.

Performance-chasing is the reality for many investors. Why? Because they may be unaware of planning and behavioral investment principles or lack the courage and self-belief to implement them consistently.

Now, let's revisit the essence of our planning and behavioral investment philosophy, which is remarkably straightforward:

1. Historical U.S. Equity Returns: A diversified portfolio of mainstream U.S. equities has historically delivered a compounded annual return of approximately 10% over the past two centuries, roughly 7% above inflation.^[iii]
2. Small-Cap Strength: Small-cap equities, due to their higher volatility and risk, have historically supplied average annual compound real returns of approximately 13%, roughly 30% higher than large-cap counterparts (around 9% versus 7% net of inflation). The volatility of small caps makes them ideal for long-term dollar cost averaging. However, ensuring that your exposure to small-cap equities is never so large that you might be compelled to sell them in a downturn is essential.
3. International Exposure: The world economy is increasingly interconnected. International developed and emerging market stocks have delivered attractive compound annual returns averaging around 8.5% for the last fifty years, and they historically show less correlation with U.S. stocks.
4. Bonds and Real Returns: High-quality corporate bonds, in contrast, have returned only about 3% above inflation over the same period, which is quite a bit less than half of the return of equities.
5. Equity Returns Dynamics: The return gap between equities and bonds is because equity returns vary significantly above and below their long-term trendline in an efficient market (see exhibit below).^[iv] While equity prices can decline considerably at times, these downturns, averaging over 15% per year since 1980 and roughly twice that on average one year in five since the end of World War II, have historically been temporary and eventually replaced by a long-term upward trend.
6. Long-Term Positivity: Specifically, over the last century, approximately 75% of rolling one-year periods resulted in positive returns, a figure that increased to 88% over five years and an impressive 94% over ten years. Remarkably, there has not been a single rolling 20-year period in which equities produced a negative compound return.^[v]
7. Bonds as a Defense: While bonds play a vital role in a diversified portfolio, relying solely on bonds as a defense against temporary equity declines requires an investor to sacrifice more than half of the long-term returns historically offered by equities.
8. Market Timing: The equity market cannot be consistently timed, just as the economy cannot forecast reliably. Therefore, the key to unlocking the full potential of equities lies in resolute, unwavering ownership through temporary declines—a skill possessed by only a small percentage of investors and often requires the guidance of a human investment advisor.
9. Asset Class Choice: The critical long-term investment decision rests on selecting the broad ratio between equities versus bonds and cash, with the choice of individual securities holding less significance in the long run.
10. Equity Diversification: Broad equity diversification is the preferred portfolio approach, dividing invested assets among funds with different styles, sizes, and geographical domiciles, which have historically run on different cycles.
11. Rebalancing: Periodic rebalancing systematically reallocates capital away from sectors that have become overvalued toward those currently out of favor, potentially enhancing long-term returns. It is important to note that this approach differs from the actions of the majority of investors most of the time.

Yet, even if quarterly and year-to-date numbers were not as favorable, we would have still recommended sticking to your carefully crafted, long-term investment strategy. While markets have historically yielded positive returns over time, their fluctuations from one quarter to another remain difficult to predict. This is why we continue to recommend the time-tested principle of staying the course.

At the core of our approach lies the firm conviction that successful investing is a long-term journey rooted in thoughtful planning and broad diversification across many high-quality companies. We remain grounded in following our clients’ comprehensive plans rather than being swayed by the tides of current events or market conditions.

We believe that consistent forecasts of the economy and market timing are elusive pursuits. This understanding drives our commitment to weather the storms of periodic market declines, knowing that history shows these setbacks to be temporary. Our enduring principles guide us as we help you strive toward your long-term financial goals.

Speaking of long-term investing, let's take a moment to acknowledge recent news that deserves our attention: On June 22, we mourned the passing of a true luminary, Nobel laureate and the Father of Modern Portfolio Theory, Harry Markowitz, who peacefully passed away at the age of 95.

When Markowitz published his seminal work “Portfolio Selection” in the March 1952 Journal of Finance, he was a mere 24 years old. He laid the groundwork for asset-class investing with this paper and future works. Some of the wisdom Markowitz imparted on the science of investing includes:

• Assembling a comprehensive portfolio that yields more predictable outcomes than focusing solely on individual securities.
• Constructing investment portfolios from diverse sources of expected returns rather than trying to predict the next big winners or evade future underperformers.
• The power of diversification as a means of risk management instead of futile market-timing strategies.

When Markowitz first started studying investments, these revolutionary insights had yet to materialize. At the time, investing meant handpicking individual stocks with little understanding of how each selection might interact within a broader portfolio. The prevailing approach to managing market risks was rooted in trying to outsmart the unpredictable nature of the market. The concept of gauging overall returns and comparing them against alternative strategies was virtually nonexistent because researchers like Markowitz had not yet analyzed the market data.

Markowitz's intellectual legacy has influenced how trillions of dollars of financial assets are managed today and expanded investors’ abilities to handle investment risks. With Markowitz’s passing, the journey continues to refine and advance our understanding of managing investment risk and returns.

1. Uncertainty is Unavoidable: Remember that uncertainty is nothing new and investing comes with risks. Consider the events of the last three years alone: a global pandemic, the Russian invasion of Ukraine, spiking inflation, and ongoing recession fears. In other words, it may have seemed as if there were plenty of reasons to panic. Despite these concerns, from March 1, 2020 through February 28, 2023, the Russell 3000 Index (a broad market- capitalization-weighted index of public US companies) returned an annualized 11.79%, slightly outpacing its average annualized returns of 11.65% since inception in January 1979.¹ The past three years certainly make a case for weathering short-term ups and downs and sticking with your plan.
2. Financial Markets are Resilient: Over the past 50 years, there have been three instances where the S&P 500 experienced a 50% decrease in value—January 1973-October 1974, March 2000-October 2002, and October 2007-March 2009. Despite these significant market downturns, American companies have managed to thrive and grow. In the past 50 years, the S&P 500 has increased 35 times and its cash dividend has risen 21 times, surpassing inflation which has only increased seven times. Furthermore, the average annual compound rate of total return (including reinvested dividends) for the S&P 500 was 10.3%, comparable to the hundred-year average, despite having experienced three halvings.
3. Emotions are Volatile: Our emotions can be one of the most volatile elements in investing, partly due to how our brains are wired. First, investors view stock market declines as “losses” instead of temporary setbacks in the long-term upward trend of shareholder capitalism. Second, these “losses” cause them totally self-generated “pain” that feels twice as bad as advances feel good. Finally—and most weirdly—they think the more the market declines, the greater the risk becomes of an even worse decline.
4. Market Timing is Futile: Inevitably, when events turn bleak and headlines warn of worse to come, some investors’ thoughts turn to market timing. The idea of using short-term strategies to avoid near-term pain without missing out on long-term gains is seductive, but research repeatedly demonstrates that timing strategies are ineffective. The impact of miscalculating your timing strategy can far outweigh the perceived benefits.
5. Stay the Course: The stock market consistently and wildly overdiscounts both positive and negative economic cycles and the fortunes of companies. As we have seen, great companies have a solidly positive long-term upward trend in earnings, dividends, and values. Furthermore, population growth, eco-nomic growth, innovation/productivity, and the law of creative destruction positively influence intrinsic values. Therefore, riding out the cycles and letting market prices migrate back toward fundamental values is best.
6. “Diversification is Your Buddy:” Nobel laureate Merton Miller famously said, “Diversification is your buddy.” Thanks to financial innovations over the last century in the form of mutual funds and later ETFs, most investors can access broadly diversified investment strategies at very low costs. While not all risks—including a systemic risk such as an economic recession—can be diversified away (see Principle 1 above), diversification is still an incredibly effective tool for reducing many risks investors face.

In particular, diversification can reduce the potential pain caused by the poor performance of a single company, industry, or country.² As of February 28, Silicon Valley Bank (SIVB) represented just 0.04% of the Russell 3000, while regional banks represented approximately 1.70%.³ For investors with globally diversified portfolios, exposure to SIVB and other US-based regional banks likely was significantly smaller. If buddying up with diversification is part of your investment plan, headline moments can help drive home the long-term benefits of your approach.

As long-term equity investors, we believe lifetime investment success comes from sticking to a well-conceived plan, while investment failure generally comes from reacting to current events.

The benefits of sticking to a well-conceived plan became even more apparent in the last three years since the pandemic started, which has exemplified the inherent unpredictability of the economy and the market.

The unprecedented worldwide economic and political turmoil has shown us that the economy cannot be consistently forecast, nor the stock market consistently timed.

As a result, we believe that the most reliable way to capture the full return of equities is to stay invested and weather the frequent, but historically temporary, declines that are a normal part of the market's behavior.

These principles continue to form the foundation of our investment policy as we work together towards achieving your long-term financial goals.

Economic and inflationary uncertainty continued in 2022. The central drama of the year—and, it seems likely, for the coming year—was the Federal Reserve's belated, but very aggressive, efforts to bring inflation under control.

The U.S. equity market rose seven times in the nearly 13 years between the trough of the Global Financial Crisis (March 9, 2009) and January 3, 2022. In 2022, the U.S. equity market sold off sharply, and at its most recent trough in October, the S&P 500 was down 27%. Bond prices also declined in response to the sharp increase in interest rates.

It's somewhat ironic that despite the many challenges faced by the mainstream equity market since the onset of the pandemic early in 2020, the S&P 500 managed to close out 2022 somewhat higher than it was at the end of 2019 (3,839 versus 3,231, a gain of nearly 19%). While not outstanding, this performance is comforting given the past three years' economic, financial, political, and geopolitical turmoil.

Our core investment strategy over the past three years of standing fast, ignoring the market noise, and sticking to our long-term plan has been validated by these results, and we believe it remains the best approach for investors.

The question of the hour is whether and to what extent the Fed's inflation-fighting efforts may cause a recession if it hasn't already. Over the coming year, the outcome will likely determine the short-term trend of equity prices. Our position remains that this outcome is uncertain and that a rational investment policy should not be based on an unknowable outcome.

However, we believe that the benefits of bringing inflation under control, which affects everyone in society, will far outweigh any temporary economic pain.

It's important to remember that we are not investing in the macroeconomy. Instead, we are investing in the ownership of enduringly successful companies poised to meet the needs of a growing (eight-billion-person) global population. We have confidence in the companies that make up our portfolios.

Accurately predicting the future is a nearly impossible feat in the ever-changing world of finance. With hindsight, it's easy to fall into the trap of thinking we could have made better investment decisions if only we had acted on our instincts. For most investors, including you and me, such thinking is nothing more than wishful dreaming.

It is human nature to remember events through a distorted lens. We may truly believe we would have made better investment decisions if we had acted on our instincts. However, an experiment by Jason Zweig of The Wall Street Journal showed that respondents to his 2022 prediction survey “remembered being much less bullish than they had been in real-time." This illustrates that basing bold investment decisions on emotions or current market conditions is not a reliable approach to maximizing future investment returns.

In their best-selling book, "Thinking Fast and Slow," Daniel Kahneman and Amos Tversky highlight how peoples' instinctual ability to interpret statistical data and forecast trends tends to be influenced by inherent biases and overconfidence. This can lead to a false sense of having insider knowledge and the ability to predict trends accurately. In their book, the authors propose a decision-making process called reference class forecasting that uses probabilities of past similar events and assumes the future will likely follow historical averages. By adopting a similar approach, we seek to develop a sound investment strategy for each client that considers historical probabilities of markets and invests based on long-term averages instead of biased interpretations of current market conditions.

A durable, globally diversified mix of stocks and bonds is still our best strategy in bull and bear markets. We’ve built your portfolio on the assumption that markets are durable over the years but can be volatile in the short term. We encourage you to recall the process you have followed to develop your personal asset allocation.

In addition, we can recall a few bear market actions worth considering at this time, such as:

• Stick with your well-planned portfolio mix and reallocate when appropriate to meet your personal financial goals.

• Periodically rebalance your account to stay on target.

• Avoid market timing because, as the recent analysis by Morningstar’s John Rekenthaler reinforces, trading on market forecasts does not reliably improve your end returns.

• Tax-loss harvest in your taxable accounts to reduce your tax bill.

• Adding to your investment portfolio while prices are low (especially if you have a long time to invest) can significantly increase your long-term returns.

• Take a close look at your discretionary spending (especially if you’re in early retirement).

• While markets may feel random, remember that the relentless wheels of global commerce drive market returns:

“Whether the currency a century from now is based on gold, seashells, shark teeth, or a piece of paper (as today), people will be willing to exchange a couple of minutes of their daily labor for a Coca-Cola or some See’s peanut brittle.”

— Berkshire Hathaway Chairman Warren Buffett

• Capturing the long-term returns of markets takes time in the market, not market timing. As the 61-year-old Warren Buffett observed 30 years ago:

“Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.”

— 1991 Berkshire Hathaway Shareholders Letter

• Being patient and preferring decades-long investment commitments has worked wonders for Buffett. You could do worse than to emulate someone who has been investing for 70-some years and has long been among the wealthiest people on the planet.

“Productive assets such as farms, real estate, and, yes, business ownership produce wealth – lots of it… All that’s required is the passage of time, an inner calm, ample diversification, and a minimization of transactions and fees.”

— 2020 Berkshire Hathaway Shareholders Letter

1. There is No Precise Definition of a Recession.

Most of us know what a recession feels like, but there is no clear definition for a recession or how it might affect us. In the U.S., the National Bureau of Economic Research (NBER) defines a recession as follows (emphasis ours): “A recession is a significant decline in economic activity that is spread across the economy, and that lasts for more than a few months.” Similarly, the World Bank Group has said, “Despite the interest in global recessions, the term does not have a widely accepted definition.”^[i]

2. Economists Usually Can’t Spot a Recession Except in Hindsight.

No single signal tells us exactly when a recession is underway or over. Instead, recessions can trigger or be triggered by many conditions, including declining Gross Domestic Product (GDP), rising unemployment, sinking consumer confidence, gloomy retail forecasts, disappointing corporate balance sheets, a bond yield curve inversion, and stock market declines.

Furthermore, a widespread downturn must linger for a while before it qualifies as a recession, and the NBER declares one only after it’s underway. For example, in July 2020, the NBER announced we’d been in a recession for two months between February–April 2020. This was triggered by the abrupt arrival of the global pandemic. It was the shortest U.S. recession to date and already over by the time the NBER officially acknowledged it.^[ii]

3. Sometimes, The Economy Gets Stuck for a While.

Recessions can become a self-fulfilling prophecy. As Nobel Laureate and Yale economist, Robert Shiller describes, “The fear can lead to the actuality.”^[iii] For example, one economic mishap feeds another until the economy feels gridlocked. It may take a while before improved conditions, a more upbeat attitude, or a blend of both help the economy move forward. When this occurs, a recession and its related financial fallout may last longer than the underlying economics suggest.

4. Recessions are Inevitable.

It is never fun to be in a recession, but it helps to recognize they are part of natural economic cycles. While they may not be anyone’s favorite tool for the job, they can sometimes help rein in runaway spending, earnings, and pricing for companies, consumers, and creditors alike.

As mentioned above, the Federal Reserve may facilitate a recession through tighter monetary policy and interest rate increases to prevent rising inflation. If we can avoid a recession, all the better. But if it takes a recession to reduce inflation, it is a necessary evil. Let’s hope it is a modest recession.

5. Experience Helps.

New investors have little perspective to help them realize recessions and market downturns won’t last forever. It’s b

een more than a decade since the Great Recession and more than 40 years since the U.S. last experienced steep inflation. Many investors have had little first-hand experience managing such turbulent times. As we gain investment experience, we learn to temper our expectations and seek support from an investment advisor.

It may help to acknowledge we’ve been here before. The table (to the right) lists nearly three dozen distinct U.S. recessions dating back to the 1850s, with an average length of 17 months.^[iv] Some were considerably longer. We endured a series of years-long recessions during the era of the Civil War in the mid-to-late-1800s. Then there was the Great Depression from 1929–1939.

6. The Stock Market is Forward Looking.

While economists may not call a recession until after the fact, stock market participants are continuously making investments based on their predictions about the future state of the economy. If you’re worried, other investors are too, and that uncertainty is reflected in stock prices. The chart below shows that the U.S. stock market tends to fall in advance of recessions and starts rebounding earlier than the economy.^[v]

7. A Recession is Not a Signal to Sell.

It also helps to remember: Every recession has eventually ended, with economies and markets thriving after that.

The chart below shows us that the U.S. stock market has averaged positive returns over one-, three- and five-year periods after significant declines dating back to July 1926.

While a recession does not accompany every bear market, the one-year average cumulative return of the S&P 500 after falling into bear market territory (a 20% decline from its previous peak) was about 20%—the five-year average cumulative return was over 70%.^[vi]

8. Time the Market at Your Own Peril.

When you start to think, “I’ll sit out until things get a bit better,” consider these words of wisdom from one of the most experienced investors of all, Warren Buffett (emphasis ours):^[vii]

“Periodic setbacks will occur, yes, but investors and [business] managers are in a game that is heavily stacked in their favor. Since the basic game is so favorable, Charlie [Munger] and I believe it’s a terrible mistake to try to dance in and out of it based upon the turn of tarot cards, the predictions of ‘experts,’ or the ebb and flow of business activity. The risks of being out of the game are huge compared to the risks of being in it.”

As the chart below shows, big return days are hard to predict, and you don't want to miss them. If you continuously invested $1,000 in the S&P 500 from the beginning of 1990 through the end of 2021, you would have $26,322. However, if you missed the S&P 500’s single best day, you’d only have $23,590—and only $16,625 if you missed the best five days.^[viii]

9. You Can’t Change the Economy, But You Can Change Yourself.

When the economy is in a funk, it doesn’t matter whether it’s due to recessions, bear markets, and other external events. Only one person can change your financial wellbeing: yourself.

Life is filled with causes and effects over which we have no control, especially concerning our investments. And yet, there are many small but mighty acts we can take to contribute to the positive outcomes we wish to see in our homes, our nation, and the world. We can manage our household budgets. We can show up for work (or perhaps volunteer in retirement). We can be loving family members, engaged citizens, and generous donors to the causes we hold dear.

And we can invest wisely. This means taking charge of your wealth by focusing on the drivers you can control and ignoring the greater forces you can’t. For example:

• We can’t avoid recessions. But we can channel our inner Warren Buffett to look past today’s risks and retain an appropriate amount of market exposure to pursue our long-term financial goals.
• We can’t avoid bear markets. But we can avoid generating unnecessary losses by panicking and selling low in the middle of one.
• We can’t avoid inflation. But we can set up a thoughtful budget to track our income and spending, with a plan in place for making adjustments as warranted.

Last and hardly least: It’s tough to change the world. But you can change yourself. Sometimes all it takes is a shift in sentiment to seize your next best move.

10. It May Be a Good Time to Revisit Your Long-Term Investment Plan.

The flood of money pushed into the system to keep the economy afloat during the pandemic also opened the door for many exotic investment ideas to hit the market. Were you tempted by meme stocks, cryptocurrencies, or a hot new IPO? If so, it may be a good time to revisit your long-term investment plan.

About half of the investable market open to public equity investors is outside of the U.S. If your portfolio is all in U.S. stocks, you are missing 50% of the investment opportunities available. You may consider starting your investment process with a market-cap-weighted global portfolio instead of chasing market segments that have outperformed in the past few years.

Furthermore, building your portfolio using institutional-quality asset class funds can help you quickly diversify across companies of various sizes and underlying fundamentals. Using funds that target specific asset classes can help you easily reduce your exposure to market segments that have become overvalued and reinvest in other parts that may be undervalued. Periodic rebalancing can help capture a balanced market return over the long run.

Beyond a well-designed portfolio, an appropriate asset allocation between stocks and bonds can help you ride out market downturns. As we mentioned above, one of the most significant risks for an individual equity investor is to get scared and sell their stocks near a market low.

An investment advisor can help you develop a plan considering volatile markets and disappointing returns. Then, they can help you stick to your plan and get to the other side when the storm comes. A sound approach to investing for you may include a written investment plan, a well-designed portfolio, and a financial advisor.

Most people intuitively understand that it would be desirable to sell stocks before a decline and repurchase them before the price increases. Unfortunately, this is notoriously difficult.

Someone is always predicting a recession is imminent, whether in the next three months or three years. It is possible that they may be right this time. However, no one has been shown to be consistently correct in predicting recessions.

As measured by the S&P 500, predicting the stock market’s price is even more difficult because the stock market has not been shown to be closely correlated with the blips in the U.S. economy—meaning the stock market does not go up and down in tandem with a recession. The stock market tends to be forward-looking and discounts the chances of a recession well before a recession begins and bottoms out and increases in value much sooner than a recession ends. Since 1945, every recession has prompted a bear market, but not all bear markets were followed by a recession.^[vi]

The table below is a chart detailing the beginning date, ending date, and the total decline of every bear market in the S&P 500 since 1960.^[vii] The chart is a frightening sight for investors. However, it is essential to remember that on the first trading day of 1960, the S&P 500 traded at 60. On the last trading day of April 2022, the S&P 500 closed at 4,132.^[viii]

Investors should find solace that from 1960 until April 30, 2022, the average annual compound rate of return of a 60/40 portfolio invested 60% in the S&P 500 and 40% in One-Month U.S. Treasury Bills was 8.13%.^[ix] The return of a 60/40 portfolio during this period is slightly higher than the long-term (96-year) average of 7.85% of a similarly constituted 60/40 portfolio.

The S&P 500 is significantly more volatile than a 60/40 portfolio, but someone invested in the S&P 500 from January 1960 to April 2022 would have earned 10.23%. The average return of the S&P 500 over the past 96 years has been 10.27%. While it is exceedingly difficult to time a bear market, it turns out you would not have needed to time the market to have a successful investment experience during these periods.