Here’s some advice for weathering double-whammy of decline in both stocks and bonds

Often, in times of stock market declines, bonds have provided a balancing effect in diversified portfolios, often maintaining their value while stocks retreat. So far this year, that has not been the case as bonds have declined significantly as well.

Over the past 173 quarters (43 years), just eight quarters have experienced negative returns for both the U.S. stock market and the U.S. bond market. That happened in the first quarter of 2022 and, so far, the second quarter is tracking in the same direction.

Bond market indexes don’t go back nearly as far as stock indexes do. Until the mid-1970s, bonds were not traded regularly. They were bought and held to maturity, mostly by insurance companies, pension funds and endowments.

In the modern bond market, there are active strategies to trade bonds before they mature if other more attractive bonds become available (usually due to changes in interest rates, like we are experiencing now). Over the past four decades, there has never been a stretch of returns as negative as what we’ve experienced over the past several months for bonds. From its recent peak Aug. 3, 2021 through the end of April, the U.S. aggregate bond market index declined nearly 11 percent. In no calendar year has this index declined more than 3 percent.

The trajectory of returns for stocks and bonds might improve. There are some reasons to be optimistic. But they just as likely could continue to trend down into the summer. There is abundant information (and opinion) to help prognosticators create investment market forecasts, but forecasts are usually of little value in the short term.

Volatility can strike investment markets at any time. Negative cycles can cause investment returns to retreat deeper than seems justifiable as psychology and investor sentiment sometimes outweigh the actual fundamental value of stocks. This is particularly true when there is a dislocation between the earnings of companies and negative news events. The Russian invasion of Ukraine, high inflation for essential expenses, persistent political circus and the ongoing effects of COVID-19 have extended the current cycle of market-influencing negative news. At other times, there are more positive news cycles and investment breakthroughs that become too exuberant.

The pendulum of human response tends to swing too far in both directions. As the pendulum swings, many investors feel the need to react, causing prices to move excessively. Ben Inker, a researcher and investment manager at GMO, once noted that the volatility of U.S. stock prices (going back to 1881) has been a little over 17% per year on average. However, Inker wrote: “the volatility of the underlying fair value of the market has been a little over 1%.” This means that over 90% of the volatility of the stock market prices each year cannot be rationally explained as a response to the fundamental factors of stock value. There is a lot of meaningless noise in daily market movements.

Successful investors tend to understand this and maintain a consistent approach to managing their decisions and behavior amid shifts in market cycles. Investment strategies tend to fare best when they are agnostic but disciplined, and based on probabilities of desired outcomes, not needing specific circumstances to appear in order for the strategy to be successful. That is necessary because we can’t predict with an adequate amount of accuracy what investments will lead the next cycle.

Because you can’t control investment market activity or the global economy, your financial decisions should rarely react to external circumstances.

Tim Buckley, CEO of Vanguard recently said: “Whether the markets have reacted to geopolitical risk, fears of inflation, or even a pandemic, time has shown that the best strategy is to stay diversified and invested. In 30 years, I have yet to meet the investor who can successfully decide both when to exit the market and when to get back in. As you well know, rebounds can come as quickly and unexpectedly as the selloffs they follow.”

It is easier to stay invested with your long-term money if you have set aside enough money for expected short-term expenses, keeping that money away from exposure to significant declines just at the time that you need it. When you know that your short-term expenses are covered, you might then feel more comfortable with letting your longer-term, growth-focused money ride through the uncertainty and occasional volatility without feeling the need to navigate around changing circumstances.

This level of commitment usually requires having a well-defined strategy in the first place. If you have a collection of investments, but not a coherent strategy for how your investments work together and integrate with your financial plan, that would be a good place to start so that you have a foundation to make decisions from when markets don’t behave as expected.