Today, I want to tie together my posts over the past week. If you remember, we talked about the mismatch between current return expectations and what history suggests as likely, and what investors could do about it. I talked about truly diversified asset allocation and regular rebalancing as a required base strategy, along with possibly using some other risk-reduction technique, like market timing, to guard against large drawdowns. This discussion was interrupted, in a very timely way, by a response to turbulence in emerging markets and a relatively large (in recent terms) market decline in the U.S. on Friday.

One of the themes of the past few posts (and of my market commentary in general over the last several months) has been the need for caution and a willingness to recognize—and plan for—risk factors.

One way to plan for them is to decide, ahead of time, what conditions would make you change your asset allocations—in this case, to dial back on risk—and then what conditions would make you reverse that again.

In the last several posts, we’ve talked about two problems. The first is that drawdowns—which is to say, losses—is a better risk measure for most investors, and something to be avoided. Portfolios should therefore be designed to avoid drawdowns as much as possible. The second problem is that market valuations are very high right now, which both raises the risk of drawdowns (back to point 1) and also makes it very likely that future returns will be below what most people expect.

Stepping back a bit, what both of these points address is the problem of terminal failure—that is, of simply not achieving your investment goals at the end of whatever your target time period is. Drawdowns can make an investor unwilling to take enough risk to reach his or her goal, while returns below expectations may also mean the goal isn’t met, even if the investor is willing to bear the risk. This is the real problem we face as investors and advisors: taking enough risk to meet our goals, but making sure that our expectations will be met in return for taking that risk.

If you look at the future returns, by valuation level, in the chart in yesterday’s post, you see that the higher the initial price, the lower the future returns. This makes sense both theoretically and empirically, but it creates a problem for investors right now, in that their expectations are totally out of line with what has happened in the past. While investors often expect miracles, many investors today are essentially relying on one—and have no idea that is the case.

The problem isn’t limited to stocks, either. For bonds, assuming interest rates remain the same, returns are the coupon payments—and then you get your money back. Your real return is coupon less inflation, which means on a par, on a real basis, with what stocks are likely to return on average. If rates rise, on the other hand, you could face capital losses, which would further erode returns. The only scenario in which bonds might make up for lower stock returns is if interest rates decline—and that’s very unlikely to happen on a consistent basis over the next decade. Anyone looking for higher returns won’t do it in bonds.

I want to continue on the path I started with yesterday’s rerun post, but a couple of things came across my desk today that, together, warrant discussion. They’re examples of the kind of slow, steady progress in the economic recovery that, over time, is adding up to big things.

Let’s start with Washington, DC. The federal government—and particularly Congress—has been part of the problem for so long we kind of expect it to be a drag. The recent unexpected budget agreement (for two years even) was a positive sign, but it left open the possibility that legislators wouldn’t be able to agree on actual spending numbers. The passage of a spending bill yesterday by the House on a vote of 359–67, with 167 Republicans voting in favor, says that both parties are now focused on solutions rather than creating train wrecks as a negotiating tool. In particular, it shows that the Tea Party caucus no longer has the power to force the rest of the Republican party to vote against a deal. You can argue over the economics or the politics, but the uncertainty created by the prior theatrics was undeniably harmful, and the fact that they’ve come to an end (at least for now) is a good thing. This is also a good signal for the pending debt ceiling negotiations early next month.

I originally wrote this article for InvestmentNews back in 2008—forever ago, in the financial world. I want to revisit it now for a couple of reasons (and also because I’m kind of proud of it). First, I think it’s held up pretty well and is still applicable, despite all the changes since then. Second, it sets the stage for an extended conversation that’s becoming increasingly important for investors and advisors.

That conversation revolves around expectations—i.e., what are you trying to accomplish with the portfolio?—and risk. We have the standard questionnaires and measures of risk and return, but, based on my frequent conversations with advisors, I’m not sure those tools really capture the dynamics of what’s going on. We need to do better.

I’ve spoken with several reporters yesterday and today, all of whom are asking, “What is happening in the stock market?” In some respects, it is a little unreal—not that long ago, a market decline of about 1.25 percent was considered normal volatility. But given how the market has climbed almost continuously for the past several months, a decline like this has people asking questions.

Perhaps they should be. The market pause since the end of last year could be suggesting a couple of things investors ought to be aware of. If you look at performance at the end of 2013, you see a consistent run-up from October to early December, a pause while everyone worried about the Fed and the taper, and then a last burst of energy. Since then, it’s been bouncing around, but with a downward trend, exemplified by yesterday’s performance.

A couple of weeks ago, we had a fairly spirited debate in an Asset Management department meeting over the economic consequences of raising the minimum wage. Just for fun, and because I like to argue, I strongly took the pro side, contending that the positive consequences would outweigh the negative. This is not a particularly common (or popular) stance in the economics and investing community, but it turns out that you can make a good case for it.

Reading through the December meeting minutes of the Federal Open Market Committee (the group that decided to start reducing the Federal Reserve’s monthly purchases of Treasury and mortgage bonds), I was very surprised. Considering the Fed has, historically, gone out of its way to be obscure, the minutes’ clarity was unusual. In the words of former chair Alan Greenspan, “I know you think you understand what you thought I said, but I’m not sure you realize that what you heard is not what I meant.”

The Fed under Chairman Bernanke has made an effort to be more straightforward, but it still tends to focus on “one hand, other hand” discussions. Harry Truman’s search for a one-armed economist goes on.

Every year, I struggle with the notion of preparing an outlook—I won’t use the term forecast—for the following year. Every year, I point out, to no avail, that it would be much better to do a forecast for the previous year: better data, much more context, and certainly greater accuracy. I’ve had no more success this year than usual, so I’m preparing my outlook as you read this.

The reason I call it an outlook, rather than a forecast, is that forecast implies a level of certainty that, even in principle, simply isn’t achievable. I used the simile the other day that the Fed’s job is like trying to repair a Seiko watch based on a Timex manual, using a sledgehammer operated by a robot controlled from the next room, in the dark, and I stand by it.