When financial markets fall and the economy stumbles, the phrase “this time it’s different” is commonly heard. This is a natural reaction as the strongest emotions tend to arise at the onset of a downturn when uncertainty is greatest. But if history has taught us anything, it’s that the most practical strategies to implement in any downturn are fundamentally the same each time regardless of market and economic events.
The COVID-19 pandemic might be unlike anything we have seen before, but the uncertainty is nothing new to a financial market that has remained strong and impervious over time. At times like this, looking at history and incorporating its lessons is always a prudent strategy.
- You Cannot Time the Market
Everyone has heard the stories from friends about Joe Rebel who knew exactly when to pull out of the market “right before” the market crash. Sure, this does happen at times, but like most stories we hear through the grapevine, it doesn’t happen as often as you think.
In actuality, selling investments is an easy decision to make. Buying them back is a more difficult one. Did this same person buy back at the bottom of the market and catch the recovery period, or did they miss the inevitable upswing and forfeit those returns in their portfolio? Let’s take a look at some influential factors.
Don’t Risk Missing the Market’s Best Days
Historically, each downturn has been followed by an eventual uptick. These upticks often include some of the market’s best days of the year (or even of the decade). But what is the impact of missing the market’s best days? It may not seem too consequential at first, but missing even a few of the market’s strongest days can substantially erode long-term portfolio value.
Take the value of a hypothetical $10,000 investment in the S&P 500 from 1/1/1980 to 12/31/2018 that either remains invested or is taken in and out of the market causing “x” number of best days missed. Here are the final values of that investment (excluding dividends) per number of best days missed in that time period¹.
|$10,000 Invested Over Entire Period
|Missed 10 Best Days
|Missed 20 Best Days
|Missed 30 Best Days
|Missed 40 best Days
In other words, during that 39-year period, if you missed just the 40 best days (or about 1 day/year), you actually would have lost money on your original investment!
Steep Upswings Happen Eerily Close to Swift Downturns
What’s even more interesting is the historical pattern of the market’s best and worst days and how they can happen back to back. Many of the best one-day returns occur shortly after a decline. For example, one of the worst down days for the Dow Jones Industrial Average (DOW) in terms of points took place October 27th 1997, moving south 554 points. The very next day marked the best upswing ever rebounding 337 points. In fact, roughly 60% of the S&P 500’s largest one-day gains occur within two weeks of its 10 largest single-session losses.
So if you pull out on the decline and sit on the sidelines until the market recovers, you are likely to miss out on a number of the S&P 500’s best performance days. These missed opportunities could seriously derail your efforts to build wealth. A professional advisor can help you handle your emotional reaction to market downturns and guide you through corrections to keep your portfolio in the best possible position and your financial goals on track.
- You Can’t “Set it and Forget it” with Investments
When was the last time you looked at your 401(k) investments and rebalanced them or made revisions to your choices if new options are available in your plan? Remember that investment returns do not happen in a straight line. If the market makes a swift move in one direction or another, your investment allocation will likely be thrown out of balance and expose you to too much or too little market risk. This could put you in a position of experiencing more downside than expected or keep you from getting all of the upside you should receive if your portfolio is not rebalanced regularly. Many 401(k) plans offer automatic rebalancing options. Check to see if that is available in your plan and if so, elect to rebalance on an annual basis.
Since company retirement plans are the most significant retirement savings vehicle for many individuals, ignoring your retirement plan may result in an unpleasant surprise as you are heading into retirement. Back of the envelope projections regarding how much money you will need to have at retirement and how long it will last are likely to result in underestimating the impact of a market downturn on your retirement nest egg. A professional advisor can monitor your portfolio as the market moves and realign your allocation as necessary so that when you are ready to retire, your retirement plan is ready as well.
- Markets Recover
Markets recover and, oftentimes, more quickly than we expect. Statistically speaking, down markets are relatively short compared to bull markets. Even though being in the middle of a downturn may feel like an eternity, the average bear market since 1950 has only lasted about 14 months. What’s even better is that the average bull market typically has lasted five times longer.
Of course, recovery times vary from downturn to downturn and portfolio to portfolio depending on the severity of the downturn and your own asset allocation at the time of the decline. It is important to have a portfolio that you can stick with (no timing!) so that when the inevitable recovery happens, you benefit fully from it. But putting together this type of portfolio is not a DIY job. Consulting with a financial advisor to construct a balanced portfolio that can weather the downturns and capture recovery gains can go a long way towards enabling you to weather downturns with confidence and ensure that your financial game plan is still on target.
4. Diversification is the Key
Diversification is a fundamental tenet of investing. It is a strategy that reduces risk by spreading your portfolio across asset categories, industries, and market sectors so that no matter where we are in the market cycle, some of the investment vehicles you carry are protecting you. It provides protection from a bad event producing downside in your portfolio that is more than you can withstand.
Allocating your portfolio between stocks (primarily for growth of principal) and fixed income (primarily for more predictable income and less volatility of principal), will give you the upside along with the stability you need to take you to and through retirement. Each of us has a different risk appetite that varies over time. Your own asset allocation should be chosen to give you portfolio performance and volatility at a level that allows you to wait out market cycles regardless of your stage in life. Your financial advisor can assist you in determining what allocation is right for you and then invest your portfolio in investment vehicles to ensure you have a well-diversified portfolio that can endure over the long-term.
An A+ Investor
Even though many of us are currently focused on our physical health, now is a great time to check up on the health of your portfolio as well. We understand that volatile markets naturally cause discomfort. Please reach out to us should you ever feel uneasy about the current circumstances, and feel free to share our information with anyone you know who may need it. We are happy to give you an up-to-date look at market conditions or discuss questions you have regarding your financial plan specifically.
Call us today to discuss how we can help you through these challenging times.