When you grow up on a farm in Iowa you learn a few of life’s truths from a very early age. You soon learn that while self-reliance is important, it’s also a really good idea to ask for help when you need it. You learn the value of family and friendships. You get comfortable with silence. And you figure out fast that throwing in the towel when times get tough will hurt you a lot more than dusting yourself off and getting back on the horse.
What, I hear you ask, does any of this have to do with equity investing in the lead up to retirement?
Pretty much everything.
In February 2020, in response to the onset of the Covid-19 pandemic, the S&P 500 Index plummeted to historic lows – shaving 33.7% from its value. But, between March 24 and April 17, the market pulled back most of this lost value with a 29% rise. Stocks have been purring ever since.
What’s the lesson?
The Simple Truth About How Markets Behave
February and March 2020 offer a pretty good reflection of how markets work, and how they rebound. The National Bureau of Economic Research recorded some interesting insights about market volatility in a working paper that explored the behavior of markets during Covid-19, and the levers at play. What’s important to note is that sentiment was more of a driver than substance. And, as we all know, sentiment can change on a dime.
Investment research company Ned Davis Research once conducted a study that examined the impact of 28 political or economic crises in the 60 years before the 9/11 terrorist attacks. The research showed that, in 19 cases, the Dow Jones Industrial Average reached new highs six months after the start of the crisis in question. All 28 cases recorded an average gain of 2.3% over these six months.
Last year, Ned Davis conducted another study that analysed worldwide health emergencies, such as the SARS outbreak (2003), Ebola (2014) and the Zika virus (2016). This analysis showed that stocks underperformed ahead of an official declaration of the global threat, but then moved higher. The same happened with Covid-19; with markets bouncing back with haste.
Great news for those who stayed invested. Less positive for those who abandoned their position amidst the fear.
Don’t Dump Your Stock (But If You Do, Get Right Back In)
If you do decide to stay the course, refrain from dumping your stocks and stay invested, there will doubtless be times when you are looking at the numbers and feeling decidedly pessimistic. This is usually in the depths of the bear market when few people have the stomach to reinvest.
Given the nature of markets, there is a simple truth which investors should hold onto during tough times: things will get better.
The problem is that unless you have a crystal ball, there is no way of knowing when you could or should get back into the market. And unless you can time it to a moment, then you will invariably miss out on a big portion of the market’s recovery when the next bull market storms in and erases all losses.
A lot of investors make this mistake, and pay dearly as a result. As financial writer and consultant Richard Best wrote for Investopedia: “The bigger risk for investors is not the next 41% decline in the market, but missing out on the next 480% gain in the market. While the past is not a predictor of the future, it should provide some assurances that what goes down does tend to go up in the end.”
Have Faith in Your Wealth Management Strategy
In the midst of crisis, humans – or rather our brains – buy into the hype swirling around us. This triggers emotional responses which can lead to irrational actions and derail well-thought-out plans. We bypass the ‘don’t dump your stock’ advice and desperately attempt to extract ourselves from further uncertainty.
In Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, financial journalist Jason Zweig talks about how the tiny amygdala area of our brains responds to possible financial losses.
He details a university experiment in Germany which scanned the brains of various investors pondering a foreign market investment and how the amygdala – the fear center of the brain – lit up. As Zweig wrote: “These findings suggest that keeping our money close to home generates an automatic feeling of comfort, while investing in unfamiliar stocks is inherently frightening.”
If that’s how our brains behave when faced with a rational decision around money, can you imagine your poor amygdala in the midst of Covid-19 uncertainty?
This is why riding out a roller coaster comes down to a whole lot of don’ts.
- Don’t dump your stock – Rather ride it out and wait for the recovery. This is harder to stomach when you are in retirement or knocking on the door of this significant life change, but you stand to lose more in the long run if you let emotions dictate your path.
- Don’t panic – Rather try to tune out news headlines and hold yourself back from checking your portfolio five times a day. Focus on areas where you do have control, like sticking to your monthly budget or paying down debt. When sentiment improves, it will pull your investments back up with it.
- Don’t throw out your plans – Absolutely take time to review your goals, explore implications for risk tolerance and time horizon ambitions, but remember that the time you’ve already taken to build a robust and diversified portfolio will pay off during times of crisis.
- Don’t turn your back on opportunity – If you have available funds, speak to your financial advisor about opportunities to enlarge your portfolio while prices are low.
For more than three decades I’ve been proud to work as an independent, fee-only investment advisor. Over the years I’ve successfully guided my clients through the savings and loan crisis of 1989, the bursting of the dot-com bubble in the early 2000s, the great recession of 2007-2009 and, more recently, the Covid-19 recession. If you need the right financial advisor to guide you through this tumultuous period, please get in touch.