As I write this, we are in the second week of June and many sectors look like they might set new peak closings soon, recovering to or beyond their pre-COVID values. However, the journey to recovery is a bumpy one, as many investors are selling as their funds approach their prior values. This is likely a foolish attempt to save themselves from a so-called second drop they believe will come. Little do they know, that selling is the only way a second drop could come.
Some investors complain, “This time is different,” because life has been very different. However, from the perspective of the markets, this time is not different. If you panicked every time the market was down more than -15.57% in a single month, you would on average flee stocks once every year. This kind of volatility is to be expected.
Allan Roth has a nice article entitled, “The Question Every Advisor Must Answer ” in which he writes:
With the recent market rally, stocks are again near their all-time highs. But we face a perilous economy, coupled with the threat of a resurgence of the coronavirus. Here’s what I tell clients who are dead-certain that the stock market is due for a significant correction.
I’m hearing statements like the following:
- An economic depression is possible, if not likely.
- There would be at least a 50% market decline.
- The chance of a rally, much less getting anything close to historical stock returns, is near zero.
- A state-issued general obligation (GO) muni bond held to maturity is safe – no defaults since 1932 – and yields 5% on a taxable equivalent basis.
- Take everything out of stocks for at least six months or until after a big correction.
Though I agree with some of those comments, here is how I respond to them, followed by what I advise clients to do.
He goes on to chronicle the value of staying invested, rebalancing and weathering the storm. He is aware of the studies that show how our behaviors cause us to get out of the markets when they are down and get into the markets when they are up. He is painfully aware that attempts to time the market are guesses at best and and that our emotions push us to do the opposite of what we should.
I especially appreciated his commentary on the last bullet point. He quotes the late John C. Bogle on the matter, explaining that in order to benefit from taking everything out of stocks, “You must be right twice.” First, you must time getting out of the market right before a correction and then you must time getting back into the market right before a rally. However, even if you get out at a high, you likely won’t be able to get back in before a rally. As Bogle continues to explain, “So if you get out now, and the market goes way down another 15 or 20%, so many investors will be so scared they won’t get in.”
Roth’s emphasis on behavioral finance (a combination of economics and psychology) suggests that investor psychology is one of the most important factors. I can’t predict which of my clients will decide to bail on a brilliant investment strategy at the wrong moment. But I agree with Roth when he says:
But should my advice prove to be wrong, or should capitalism actually fail, I assure my clients that, “I’m going down with you.” Oddly, it makes them feel a bit better. People hate losing money, but they hate it a bit less when others lose as well.
Investing in index funds is dull, but as Roth would say, “Dare to be dull!”
In the long term, the markets are brilliant at setting appropriate stock prices. In the short term, though, they are fickle and volatile.
Having a long-term investment strategy and the discipline to rebalance is the guide to get you through the storm. When you rebalance instead of following the crowd, you set yourself up for greater expected returns and are the definition of being a contrarian.
For more on daring to weather any storm, you may enjoy reading our article “Remembering The 2008 Crash as a Financial Planner” where we remind us all:
If you sell to cash when the markets go down, it almost never turns out well. It ruins a retirement plan. It impoverishes an otherwise brilliant investment strategy. And it isn’t just the numbers. This is your life. Your financial freedom and financial needs are at stake. Sometimes, you don’t get a second chance to be brave. Stay the course. Rebalance.
Photo by Francesco Tommasini on Unsplash