You probably already know the rational steps to take during a financial crisis: Don’t look at your 401(k) or investment accounts. Don’t stay glued to the cable TV business channels or bury yourself in reports by the financial press. And, above all else, do not panic-sell your investments. Trying to manage any short-term market-timing during a period of panic selling can be one of the most difficult aspects of investing.
Many of us (too many) have already lived through several financial crises at this point, but that doesn’t make these events any less scary when they occur. A crisis can happen overnight (as in the October 1987 crash) or over the course of a year (as in the late-1990s dot-com bubble). Crises can be brought on by the bursting of stock market bubbles, specific ill-considered industry practices such as the early-2000s ratings of subprime mortgages, or (as we are now experiencing) a “black swan” event such as a pandemic. No two crises are alike, but they all have one thing in common: over a subsequent period, the market has recovered every time, no matter how devastating the losses nor length of time it took for the recovery.
New to This?
Now a new generation of investors is experiencing its first genuine financial crisis. For many millennials, no soothing advice to stay calm and carry on can ease the pain of their first time watching their life savings evaporate in a few weeks. When the value of your portfolio plummets so far and so fast, it hurts—and not just metaphorically. According to scientific studies, our brains respond to financial losses in a way that mirrors the response to physical pain. When faced with the pain of financial loss, people seek to avoid further pain in a visceral rather than rational way.
Hence, the powerful urge to sell during periods of uncertainty.
But there are only two days that really matter in investing: the day you buy and the day you sell. All the ups and downs in between? Those are simply noise. If you can learn to ignore the noise and stick with your investment plan, you’ll do just fine. Through past crises, the downward market has lasted days, months, or in some cases, years; however, it has always sharply rebounded and rewarded the patient investors in the end.
No one can predict exactly what will happen next and how long this particular crisis will last; that’s the risk of market timing. But if history has taught us anything, it’s that the market recovers, and so do we. Panicking will only create more sleepless nights and increase the risks. Nobody knows when the market sell-off will end and a new uptrend will emerge.
Stay the Course
Remember, you are buying companies, not just stock. Businesses are still running, and the world is still operating. Don’t try to time the market. Maintain a buy-and-hold mindset. If you are invested in high-quality equities and your investments are based on a solid plan, don’t sell anything that you wouldn’t sell in calmer times when there isn’t a crisis. The only exception to this rule should be is when it’s absolutely clear that a company or niche industry isn’t going to recover any time soon (i.e. travel, entertainment, cruise industries, all hit hard by the current crisis); then it may be time to cut those specific losses and try to avoid getting suckered back into the market too early. This does also depend on your risk tolerance.
Evaluate Your Risk Tolerance
Your risk tolerance is an important part of your investment plan. Risk tolerance is the amount of uncertainty you are willing to take on to achieve potentially greater rewards. It’s determined by several factors, including your investment goals and experience, time horizon (the length of time you expect to hold the investment), and other resources. The best way to gauge your risk tolerance is to take your pulse during a crash. How are you feeling? Are you considering selling everything and hiding your cash under the mattress? Then your risk tolerance may be lower than you thought. Once the market recovers and stabilizes (which it will), reevaluate your portfolio risk if necessary.
When Do I Reinvest?
We don’t know how deep the market will go down. No one can predict this. So, investors should have their own strategy to deal with the situation. You must be patient. The market will always move up in the long term. Investors might be thinking, therefore, that there are bargains to be had. But buying into market crashes, it’s said on Wall Street, is like trying to catch a falling knife. When is this ever wise?
If you want to take advantage of low prices, consider a dollar-cost-averaging strategy. This is when an investor places a fixed dollar amount into an investment on a regular basis. The investment generally takes place every month (or other fixed time period) regardless of what is occurring in the financial markets. This type of investing can provide more price-volatility protection than if you invested a large sum at one time. It is better to slowly feed into the market as it can still be volatile and have swings.
The S&P Swings
The S&P 500 has gained in value an average of about 7% per year in compounded annual returns. Add in the dividends and it jumps to 10% annually. That’s across bull and bear markets, oil shortages, wars, and global recessions. Historically, we get a 10% market drop every two years on average, and since 1950, stocks have fallen 20% or more only 11 times, about once every six years. Declines of 30% or more have happened only five times.
Usually, the market recovers more quickly than people expect. The S&P 500 fell 20% from October 1 to December 24 in 2018, but fully recovered by April 2019. Things do return to normal, businesses get back to doing what they do best, and markets go up. Just because this time feels different, doesn’t mean it’s going to have a different result. Life will return to normal just as it always does and, one hopes, society will have learned lessons about caring for one another and practices to reduce the threat of another global pandemic.
Be Prepared
If you do decide to step into the market, have a plan. Your time horizon should not be the next ten weeks or so, but longer term. Not sure about the difference between an ETF and mutual fund? Check out our Bowen Report: https://bowenasset.com/whats-an-etf-and-why-isnt-it-a-mutual-fund/
Whatever you decide, use caution, patience, and prudence. Don’t panic.