The Magnified Impact of Investor Sentiment
A thought on your portfolio's "total return." (If you were told there would be no math today, I apologize in advance.)
Total Return has two parts to it: appreciation & income. If you view owning a stock like you are an owner of a company, you want it to be profitable and have solid cash flow. That perspective makes it easier to focus on the yield generated in your portfolio (dividends and interest). However, as an investment, you also consider appreciation, which can be much more speculative, or at least fickle in nature.
Think of something as simple as the P/E ratio, which is just another way of saying how much you're willing to pay for an investment for every dollar of a company's earnings It's one representation of investor sentiment. Why is this important? Because uncertainty impacts investor sentiment in addition to the potential impact on corporate earnings.
Consider the two investors below. Let's assume that the S&P 500 is around 6100, and both use research that shows the estimated earnings for the S&P 500 will be $280 over the next 12 months ("forward earnings"). This puts the forward P/E at roughly 21.8.
Ryan wants to manage his portfolio risk.
Ryan is 30 years old, is a high earner, and has some additional cash that he would like to invest. However, he is also concerned that the market is going to come down significantly for a number of reasons, so he doesn't want to invest right now. Instead, he guesses that the forecasted earnings for the S&P will only reach $260, not $280. Not only that, but Ryan isn't willing to pay the same amount for those earnings. He will only invest if the forward P/E ratio reaches 20. So because of his conservative nature, he doesn't want to invest more in stocks until the market comes down to 5200. So even earnings estimates go down by about 7%, Ryan needs to see a drop of 14.75% before he feels comfortable and confident that he can get a reasonable return.
Austin wants to be more aggressive.
Austin is also 30 years old, is a high earner, and has some additional cash that he would like to invest. He has some concerns about the current market, but is more optimistic than Ryan. While he also thinks that forecasted earnings will only be $260, he is still willing to pay $21.80 for every dollar in earnings (P/E ratio of 21.8), so he plans on investing more if the market pulls back to 5668 from 6100 (a decline of 7.08%).
There is no "right" answer. Math can tell you what you may "need" to do given certain conditions, but are those conditions actually right for you? This is why the "soft stuff" matters; it helps you understand your investing style when the market gets tough - because it will. In a world where we talk about love languages & attachment styles, it is just as important to understand what works for you and how you want to move forward - financially speaking, of course.
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