“It seems like this Kim Jong Un is insane. Based on his testing missiles close to Japan and Trump promising to confront him, a military confrontation seems inevitable. What happens if he nukes South Korea? Shouldn’t we get to the sidelines and then get back in when things settle down a little bit?”
“This pandemic is out of hand. Stocks are crashing, we have no idea when we will have a vaccine or how safe it is. Americans are dying. Our hospitals may get overrun and we might not even have enough protection equipment to keep healthcare workers safe. Shouldn’t we get to the sidelines until things settle down a bit?”
“It’s beginning to look like Biden might win the Presidential election and it’s even possible that Democrats could win the house and Senate. Won’t higher taxes and more regulation be bad for stocks? Shouldn’t we get to the sidelines and then get back in when things settle down a bit?”
My answer is almost always the same
When we decided how much to have in stocks we gave our asset allocation careful consideration, knowing that every ten years or so there would likely be a significant bear market. We never know in advance why or when or how severe that bear market will be. We established the percentage we invest in each asset class because, while we wanted to own some investments where the principal was secure, we recognized that historically stocks have represented an asset class uniquely suited to maintaining purchasing power over time. We considered it carefully in light of your goals, risk tolerance and the historic returns and volatility of different asset classes.
But don’t the crazy things that are going on in the world dictate that we need to change our approach? The short answer is no. Even if we knew how the North Korean Crisis/Pandemic/Election would work out (we didn’t/don’t), it is unlikely that we would be able to get out of the market and then back in at a better price “when things had settled down”. As a matter of fact, if stocks moved lower in reaction to scary news after you sold, that feeling in your stomach and the reinforcement of your fears by the media would make it virtually humanly impossible to buy stocks back at a lower level. In my thirty five years as an advisor I have never come across someone who could reliably make and institute the “get out and get back in lower” strategy in the face of bad news. The tax consequences of this strategy in a non-retirement account can also present challenges.
But here is what I do know. Over long periods of time (10 years or greater) stock indexes have rarely had a negative return. When ten-year returns have been negative, those losses were modest (Crestmont Research). Over long periods of time stocks have generally performed better than bonds and cash (Shiller Index 1871-2019). That makes sense because if people were not rewarded with higher returns it would not make sense to accept stock market volatility.
Assuming that one has a reasonable approach to owning equities, (There are many smart ways to own stocks, including mutual funds, Exchange Traded funds, indexing, direct company ownership), how much should be in the stock market? Once you thoughtfully establish an allocation, with a plan to rebalance the portfolio appropriately, what are good and bad reasons to sell stocks, lowering your equity exposure?
- Time Frame-If funds are needed for a specific purpose within a relatively short period of time (5 years, very conservative, is my guideline)
- Temperament-If you will suffer intolerably from what is almost certainly a temporary, albeit significant markdown to the value of your portfolio
- Behavior-If lower stock prices and the accompanying and inevitably terrifying news flow that follow will lead you to sell stock into a bear market
- “It’s different this time”-According to Crestmont Research, there have only been a few 10 year periods when stocks as measured by the S&P 500 lost value, and those losses were less than 5%. If you believe that stock market returns over the next ten years will be radically worse than any ten-year period in stocks in over a century, you should invest less in stocks.
- “We can get back in at lower prices”-I stated earlier why I believe that is unlikely. Assuming that we are unlikely to get back in lower, what is the harm of getting back in higher when it feels better? Whether it is through a formal financial plan/projection or a directional strategy for retirement (saving and investing as much as possible), your options in life/retirement depend in part on the returns you get on your investments. Getting out of the market and reinvesting at higher prices lowers the returns on the asset class in which you are investing. Nobody knows what stocks will return over the next decade, but if we assume a 7% annual return and you lower that to 4% with your investment behavior, you have not helped yourself. Studies have shown that investor behavior (selling low and buying higher) acts as a drag on returns (Marketwatch). This discussion is not hypothetical.
If you had told me that the “North Korea Crisis” would go from confrontation including threats of war to a friendship between the leaders (including personal letters) and a meeting at the Korean border to an awkward lack of further developments with almost no effect on stock prices, I would not have believed it.
If you had told me that the stock market would rally over 40% while over 100,000 Americans died of a mysterious disease with no vaccine yet developed and about 20% of the economy and an even higher percentage of small businesses either out of business or at a standstill, I would not have believed it.
I don’t know who will win the election. If I knew who will win the election, I could not tell you with meaningful certainty what the markets will do based on that information. Consensus seems to be that if Biden wins and the Democrats sweep the house and Senate stocks will go down. That could certainly happen, but the average return of the S&P 500 when such a Democratic clean sweep has happened since 1951 has 13.2% (LPL Research, FACTSET 7/14/2020). I don’t know what will happen. I have no “edge” in guessing who will win OR in guessing how the markets will react to that victory. So I will hang my hat on 150 years of stock market performance and an allocation of my assets that I can live with. I will try to do the same for my clients.
During past crises, had I listened to my gut in managing client accounts versus utilizing a more rules-based approach to investing, performance would have suffered. I know people who STILL have not reinvested in stocks since they “got to the sidelines til things settle down a bit” during the 2008 financial crisis. Missing a twelve year rally that triples the value of my equities in a low interest rate environment is an investment risk I am not willing to take for myself or for you.
