Market Perception and the Captive Audience
Without a doubt, we are living through historic times. The shutdown of the global economy and the accompanying speed of the declines in stocks rivals the steepest selloffs in history. This crisis is playing out against an almost inescapable backdrop of news coverage and social media. This creates a potentially toxic combination of investors confined to their homes in front of an endless stream of negative headlines.
This anxiety is exacerbated by the nature of how financial news is broadcast, which causes many investors to miscalculate the impact of market moves on their own portfolio. The stock market fluctuations are easy to observe on the news (green numbers when the market is moving up, red numbers when the market is declining). This makes for a simple calculation of “how much money my portfolio is losing” on a particular day. But what is rarely talked about and not so easy to calculate is the movement of the bond market, which typically holds up well during stock market downturns. This means holders of a diversified portfolio that includes bonds often overestimate their losses when stocks are falling. This dynamic raises the risk of panicked decision-making when investment discipline is needed most.
We’ve Been Here Before
The cause of this bear market is unique, but the behavioral response investors are tempted to make has always been the same: panic selling at the most damaging times. This is not the first time we have seen so much red, and it will not be the last. One of our important roles is to stand in the way of damaging emotional decisions that could irreparably harm long-term growth potential. As recently as 2008-2009, and again today it is common to hear the greatest misconception held by prisoners of the moment: “This time is different.” Without history as a guide, investors can lose their way, take a short-term and emotional view, and lock in losses before a portfolio is given a chance to recover. History teaches us that every bear market does has one important thing in common: they have always recovered. By holding fast to a long-term and disciplined approach, investors with diversified portfolios can achieve their ultimate goals despite these bumps in the road.
Proven Foundations of Successful Investing
Our counsel is based on time-tested, academic principles, not gut instincts or speculation about what will happen tomorrow, next week, next month or next year. This is the foundation of a comprehensive wealth-management plan. The most critical aspect of this foundation is proper asset allocation. Portfolios with the appropriate balance of bonds, cash, and stocks provide for current needs without being forced to sell stocks in the midst of bear markets. Adequate allocations of bonds and cash provide multiple years of reliable cash flow to survive even the most severe bear markets. A focus on diversification and portfolios of high-quality stocks and bonds further insulates portfolios from unnecessary long-term damage.
Disciplined Investing for the Long Term
History provides ample evidence to support the long-term approach of staying invested. For example, the average three-year return following the last 12 bear markets (some worse than this one) is 89%. Five years later the market had gained 132% on average. No one knows when the market will bottom and begin to rebound, but history suggests that it will.
A fear-based strategy of selling stocks, moving to cash, and trying to time exactly when the bottom will occur has proven unwise historically. This “strategy” can do incredible harm to a portfolio. A study recently showed that missing just the five best days between 1980 and 2018 resulted in a portfolio value 34% lower than staying fully invested. It’s worth noting that some of the best market days occur right after some of the worst market days, as we have seen in recent weeks. Because it’s impossible to know when these will occur, the only way to get the benefit is to be in for all days, including the tough ones.
The volatility in recent weeks has been nothing short of historic. We have experienced two of the worst single-day selloffs in history, and the fastest-ever 30% decline (22 days). But we know the storm will eventually pass. The time will come when the “green days” once gain outnumber the red ones. Until then, we remain committed to the time-tested principles that have allowed clients to achieve their goals through the good times and the bad.