2 Things You Should Do Right Now If You're Panicked By This Market
The coronavirus-inspired bear market in equities that has knocked many investors back on there heels has been and unfortunate and swift reminder that prices don't always move in a nice, steady upward trajectory. There are corrections occasionally and bear markets infrequently, but they do occur from time to time and are a normal part of the market cycle. While investors haven't experienced a true bear market since the financial crisis, these types of events are simply part of the price for playing the game.
Over the past few weeks, many have gotten a crash course on what their true risk tolerance. Everybody is happy to be fully invested in equities when the VIX is around 12, GDP growth is around 2-3% and the unemployment rate is below 4%. Those times are the low hanging fruit for investors, but a black swan event, such as the coronavirus showing up with little notice, can test even the most experienced investors.
As the resident "money person" in my family, I've gotten no shortage of emails, texts and phone calls in recent weeks and, I've got to say, it's been a refresher course in behavioral finance. Loss aversion, herd mentality and confirmation bias and the consequent actions taken as a result are the sorts of things that investors do that shoot themselves in the foot trying to reach their financial goals.
You won't be surprised to know that the only question I got was "should I get out now?". For some, it was a genuine question of what they should do. For others, their minds were already made up and they were simply looking for confirmation that they should do it. For all, it was a good reminder that times like these are an ideal opportunity to take a look in the mirror and see where you really stand on these in times of crisis.
If you're one of those folks that is watching 1,000+ point daily swings in the Dow and feeling sick to your stomach, I recommend that you do two things today to set yourself up for long-term financial success.
#1 Reassess Your Financial Goals
Ask yourself this: What are you saving up for and how long until you need to begin accessing the money?
For most people, the answer to the first question is retirement. The answer to the second question could be anywhere from now to 50 years from now. Given that the S&P 500 returned more than 250% during the 2010s (with dividends included) with only drop of 20% (which was quickly recovered), it was easy to keep virtually 100% of your portfolio in stocks regardless of where you were on the retirement planning cycle and not think twice about it.
Now, investors are experiencing the downside of that strategy.
If retirement is your primary goal, you should have an asset allocation appropriate to your age with the understanding that you're allowed to make tweaks based on your own preferences. Fidelity provides a nice guideline for what asset allocations should look like, in general, at specific ages.
Even for the youngest retirement savers, a small allocation to bonds is still recommended. Given enough time, the bond investment probably won't enhance the returns of a portfolio since stocks tend to outperform over the long-term, but they have important risk reduction that are especially important in volatile times.
By the time you become middle-aged, that allocation to bonds increases until you near retirement age, when the overall allocation is expected to shift to a majority of fixed income.
Again, these are just guidelines, but they show how investors shouldn't necessarily be going all in on stocks, especially those who are older.
But the overarching theme here is that retirement savers should expect and accept short-term corrections and bear markets in the pursuit of long-term returns. If you've got years and years until you plan on needing the funds, staying put and riding out the volatility has proven to be more lucrative over the long-term.
This is a bit of an older graphic, but illustrates well how investors can shoot themselves in the foot by trying to time the market or panic sell when the market is down.
source: Capital Spectator
Fund companies publish annualized returns assuming that investors buy and hold. In reality, the typical investor earns about half of that. That's because they typically overreact to market volatility by buying high when the market is rallying and selling low when prices fall. And it's often difficult to time the inevitable rebounds, which often come swiftly and unexpectedly. As strange as it may sound, you're likely better off accepting short-term losses because it means you have a better chance of achieving superior long-term returns.
If your goal is college saving, the same general principle applies - you can maintain a higher equity allocation if college is years off, but you should shift to mostly fixed income as the date draws near. Saving for college can be especially dangerous if you're over-exposed to equities during a bear market if the kid, for example, is already in high school. Depending on how one would be invested, a 100% equity portfolio could have lost a full 1/3 of its value over the past month. That's awfully bad timing since now there's very little time to recover those losses.
The overall guidance here is to keep an eye on the big picture. Whether your goal is retirement, college saving, building an emergency fund, saving for a house down payment or whatever, make sure you have a clear understanding of when you anticipate needing the money and invest in a risk-appropriate manner. The Fidelity graphic above is focused more on retirement saving, but it's still a good framework to use for understanding what a sample asset allocation might look like depending how many years out your goal is.
#2 Reassess Your Risk Tolerance
I'm guessing that a lot of investors found out they aren't quite as comfortable with risk as they thought they were a few weeks ago. Everybody tends to be comfortable with risky assets when the VIX is in the 10-15 range, but when it does this...
...it's a different story!
One family member of mine, for example, sounded downright ill when she mentioned how much her IRA was down (funny how people can usually give you an exact dollar amount of how much they lost during a downturn!). She pulled everything out and moved into cash, but only after her account was down more than 20%. Like I mentioned earlier, odds are that she'll miss out when the markets hit bottom and will come out worse in the end.
I won't get into the debate here of whether this was the right move of not, but the more important point is that she shouldn't have been in an all-equity portfolio to begin with. Nobody enjoys losing 20% of their portfolio's value, but if you feel physical pain when you check your account balance, you know it's time to make some changes.
Many point to the idea of wanting to maximize absolute returns, but maximizing risk-adjusted returns can be just as important. Sure, you're sacrificing some return in the long run, but you're also going to be much better protected when a severe downturn occurs. If you had a 50/50 portfolio of the SPDR S&P 500 ETF (SPY) and the iShares 20+ Year Treasury Bond ETF (TLT), your total year-to-date return would be somewhere around -2% today. That's a big improvement over the 20%+ losses in the S&P 500 alone.
But it's important to be honest with yourself. If you been shaken by the recent volatility and have at least considered yanking your money out of stocks, you should at least consider moving to a more conservative stock/bond allocation.
People tend to underestimate the importance of being able to sleep at night. But the consequences of panicking and overreacting to the gyrations of the market can ultimately cost you both financially and physically!
While the major damage has already been done, the current bear market is still a great opportunity to reassess both your goals and risk tolerance. Make sure that your portfolio's asset allocation is aligned with when you plan on accessing the money so as not to put yourself at heightened risk of losing excessive capital at the wrong time.
And be honest with yourself about what your true risk tolerance. Too many people want to swing for the fences when it comes to achieving returns in their portfolios, but there's nothing wrong with singles and doubles! Taking more risk than you're comfortable with often leads to irrational decision making that can severely impact the type of returns you'll actually get.
The current bear market is painful for many, but reassessing your goals and risk tolerance can still set you up for much future success!
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