What Happens After The Stock Market Has Huge Gains?

I can’t go a few days without someone asking me when the market is going to roll over.  It’s gone almost straight up for five years and that just isn’t sustainable, right?  As readers of this blog know, we prefer to take an evidenced based approach to investing portfolios, so I thought it was about time we look at the evidence.  The S&P 500 has generated an average annual return of 18.83% per year (including dividends) for the past five years, through June 30, 2014.  For my research, I looked at all rolling 5 year periods in the S&P 500 since 1926 that had returns greater than 20% per year.  In addition, I analyzed the 5 year return immediately following the 20%+ return in the market.  Here are some of the stats I found:


Rolling 5 year periods following 20%+ returns

All rolling 5 year periods periods













Std Dev



These results tell me two key points:

  • Market returns are on average lower (but still solidly positive) after 5 year periods where the market goes up greater than 20% per year
  • Just because the market has gone up a lot the last five years, it is no reason to abandon stocks

It’s human nature (especially after 2 bear markets in the last 14 years) to think that what goes up, must surely come down, but evidence tells us that this is not typically the case.  This is just another reason on why it is so important to let the facts drive our decision making.

Calling The Next Bear Market

When is the next bear market coming?  There seems to be no shortage of prognosticators that are willing to share that information with you.  Unfortunately, the accuracy of their predictions leave much to be desired.  The Big Picture blog has compiled a list of articles over the past several years that probably seemed compelling at the time:

We’re In a New Bear Market, Says One Technical Indicator – Wall Street Journal, 8/12/11
Signs of a Crash Ahead, Not a Recession – New York Times, 9/28/11
Wall Street Approaches a Bear Market – New York Times, 10/3/11
What if There’s a Bear Market in 2012? – Forbes, 12/29/11

3 Reasons Why the Bear Market is Back – Yahoo! Finance, 5/23/12
A bear market in bull’s clothing – MarketWatch, 8/27/12
Big-name stocks fall into bear markets – USA Today, 11/9/12

An epic bear market is coming – MSN Money, 1/2/13
Bear Market to Take Hold in 2013: Expert – CNBC, 3/14/13
Bear Traps Await Investors – Wall Street Journal, 7/31/13
Doomsday poll: still a 98% risk of 2014 stock crash – MarketWatch, 12/21/13

Is The Next Bear Market Here Already? – Nasdaq.com, 4/2/14
Buckle Up! The New Bear Market Has Begun – Seeking Alpha, 5/8/14
Two signs a market crash is coming – Yahoo! Finance, 7/17/14
Three Signs That Point to a Stock-Market Tumble Ahead – Wall Street Journal, 8/1/14 4
Signs this bull market is on its last legs – MarketWatch, 8/13/14

I’ve had to refute many articles like these, forwarded on to me by clients that become scared about what they’ve read.  Every response tends to go something like this, ” the author may be right, but no one knows what the future is going to bring, so we should be careful about acting on this.”  Thankfully, I can’t think of one client who has acted on their initial impulse after we’ve had a chance to discuss it.  The real point to remember here is that magazines and websites are not designed to advise you.  They are there to get your attention.  That’s their business model…they need readership, views and hits.  How do they do that?  By publishing sensational headlines and stories.  How many articles would you really want to read about staying the course, diversification and keeping costs low?  It’s boring, but it works.

401k Advice? I Don’t Need No Stinkin’ 401k Advice!

Schwab Retirement Plan Services recently announced the results of a nationwide survey of 401k participants.  When it comes to getting professional 401k advice only a small percentage of participants actually got help even though most people acknowledged their need for such advice and the confidence that would come from it.  Participants were much more likely to get help for the following things:

  • 87% – Changing their oil
  • 51% – Installing a new faucet
  • 36% – Preparing their taxes
  • 32% – Getting help landscaping
  • 24% – Getting help making 401k investment decisions

Clearly, this is more evidence that we have an engagement problem when it comes to getting most people to save and invest wisely for retirement, even though people recognize the need to do so and the peace of mind that comes from with it.   

Schwab has put together a really nice infographic that summarizes the results in more detail: Schwab 401k Survey Infographic

In-Plan Roth 401(k) Conversion- Is It Right For You?

A Roth IRA is a wonderful vehicle, especially if someone has already maxed out their other tax-advantaged accounts (e.g., 401K).  For those not eligible for a Roth IRA or those who just can’t get enough Roth, there is a relatively new option – an in-plan conversion from a traditional pre-tax 401K to a Roth 401K.  Because of 2013 legislation, more participants than ever are now eligible for this conversion (as long as their employers’ plans allow it).

 The decision to convert from a standard 401K to a Roth 401K is similar to determining whether to convert from a traditional IRA to a Roth IRA. While there are numerous considerations, the primary advantage is that once it becomes a Roth, no additional taxes will be due.  The downside is that taxes must be paid now at one’s ordinary income tax rate (and in most cases, the taxes should be paid from non-retirement accounts).  The benefit of converting is due to the concept of “tax diversification” – owning some assets that are taxed now (e.g., Roth) and some assets that will be taxed in retirement (e.g., traditional IRA/401K).

For someone earlier in his/her career who might be at a lower 10%-15% income tax rate, a conversion could be a good strategy since rates are likely to be higher (or at least the same) in retirement.  But for someone who is a high earner, the additional income from the conversion could trigger a higher marginal tax rate as well as a phaseout of deductions and exemptions.  For these individuals, converting a large lump sum might not be optimal.

Due to the complexities, two sensible strategies could be to a) Contribute a portion of your 401K to a Roth.  For example, if you contribute $10,000/year, consider $5,000 for the traditional 401K and $5,000 for the Roth 401K; or b) Instead of a full conversion, convert smaller amounts each year to minimize the tax ramifications in any single year.

As we’ve said before on this blog, it’s very hard to estimate tax rates 10 years from now, let alone 20 or 30+ years away.  Before converting a large amount, talk to your accountant and financial advisor so they can help customize a solution for you.  

What Stories Can You Believe?

Does it ever pay to try to pick stocks that will outperform?  Maybe, but lots of research shows that the small group of stock pickers that exhibit positive results are more likely due to luck than skill.  It doesn’t stop us from trying though…many of us are lured by the siren song of having information that will allow us to outperform the market.  I just read an article by an investment firm that claimed that there were opportunities for selecting stocks in emerging markets because of the ability to exploit inefficient markets:

Good news: alpha potential remains high. The flow of information about countries and companies is slower and less transparent in developing markets, creating mispricings that resourceful stock pickers can exploit. 

If that were true, you would expect to see a good number of professional managers who invest in emerging markets outperform their benchmark.  If you really can develop an edge, the numbers should back up your claim.  Unfortunately, the data does not support this view.  Standard and Poor’s twice a year research report (SPIVA) found that 80% of all emerging market mutual funds failed to outperform their benchmark during the five year period through 12/31/2013.

Stories can sound compelling.  It is important to focus on the evidence when making investment decisions, especially when the person telling you the story has something to gain from you believing it!

Information contained herein has been obtained from sources considered reliable, but its accuracy and completeness are not guaranteed. It is not intended as the primary basis for financial planning or investment decisions and should not be construed as advice meeting the particular investment needs of any investor. This material has been prepared for information purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Past performance is no guarantee of future results.