We get it, it’s natural and justified to be worried about the coronavirus (COVID-19). As the virus spreads around the world, still much is not known, including the severity in the U.S.
It’s important to remember that most people have an allocation to both stocks and bonds. Bonds have been a common complaint from people over the past few years for their low yields and returns, however it is precisely in times like these we are thankful to have them as part of the portfolio. In recent days bond prices have been increasing as they are seen as an area of safety – and they help to offset some of the falling prices with stocks.
Stock prices have dropped precipitously this week. This is mainly due to anticipation that the effects of the virus could cause a slow down in economies around the world.
As a diversified stock investor, it’s important to take a step back and understand the true dynamics that are at play. You are an owner of businesses. As an investor in a broad based US index fund, you are an owner of Apple, Amazon, American Express, Berkshire Hathaway and hundreds of other companies. To paraphrase what Warren Buffett said on CNBC the other morning, “The main question an owner of these businesses must ask themselves is what are the prospects for the growth and value of these companies in 5, 10, 20 years from now.” We agree with Mr. Buffett’s answer to this question, that the prospects for business are quite good, and being an owner of businesses via the stock market will continue to be one of the best ways to get positive inflation-beating, returns on your money over time.
We work with a lot of people that have recently retired. A common concern we hear, especially in times of volatile markets, is that they understand the stock market is good over long periods of time, but as a retiree they do not have this long investment time horizon. First of all it is very important for a retiree to evaluate the risk level of their portfolio and come up with a ratio between stocks and bonds that makes sense for their situation. However, we firmly believe that most retirees are in fact long-term investors for the portion of their funds invested in businesses via the stock market. We are typically planning for growth and income over a 20 to 30+ year period. During these long periods of time there will be inevitable corrections, downturns and recessions. This is all a normal part of the investment process – even for retirees. And this is all built into the retiree income analysis and withdrawal strategies.
What do we do?
Since we talk about this all of the time in meetings and via emails, you very well already know that our first piece of advice is not to make any knee-jerk reactions to the market downturn.
Why does this seem to always be our response, you may be wondering? The answer is that it is nearly impossible to time things correctly in order to gain an advantage within your portfolio.
You have to be right twice:
By “time the market” we mean selling some of your stocks before the downturn and then buying them back before the eventual rebound. For an example of the near impossible task of attempting to time the market one needs to look back no further than 2008. In early 2008 the stock market went into a free fall as the housing and financial crises’ came to a head. 2008 ended up being the second worst year for the US stock market in its history, the S&P 500 was down approximately 40 percent.
Even if someone saw these events coming, and had the foresight to get out of stocks by the beginning of 2008, they have still only completed half of the equation in order to have successfully “timed the market.” Next they need to pick a time to repurchase stocks, while prices are still lower, to take advantage of the eventual rebound in prices. The stock market is a forward-looking, information processing machine and rebounds or increases in prices often happen at very unexpected times.
In early 2009 the news and impact from the financial crisis was still quite bad, and getting worse in many respects. The unemployment rate was increasing to rates not seen in recent history, people were losing and foreclosing on homes at an unprecedented rate, and the overall sentiment for the economy was down right lousy. This was the precise moment the stock market decided to have its rebound, and it was a recovery that was quite dramatic. 2009 ended up being one of the best years in the history of the US market. The point being, it would have been awfully difficult in the face of all the gloomy news and prospects, that one would have had the fortitude and foresight to decide that this was the precise moment to re-enter the stock market. You can’t be right just once, you need to be right twice.
Is there really nothing we can do?
We think there are strategies we can employ that have a much higher degree of success and value, such as rebalancing – this is the systematic process that maintains your allocation between different categories of investments, at a high level, stocks and bonds. If a retiree has an investment policy statement that calls for 60% of their portfolio in stocks and 40% in bonds, this could give us an opportunity to rebalance the portfolio, selling a small portion of bonds (which have increased in value) and buying stocks (which have decreased in value) with the proceeds. Maintaining the asset allocation target percentages is fundamental to a successful long term outcome, and it essentially is a process-driven technique that allows for investors to “buy low and sell high.”
As always if you have any questions please don’t hesitate to reach out to us.