Many people seem to invest rationally, until the going gets tough. Then we often throw our reasoning out the window while making a mad dash for the exits.
It shouldn’t be like that. Here are some common-sense reminders that are worth heeding during volatile stretches in the stock market like now, with coronavirus anxiety seemingly everywhere.
You’re not going to lose everything
During times of heightened market turbulence, how often have you heard someone voice the fear of “losing everything” or getting “wiped out?” Sure, that’s a possibility, albeit remote, with an individual stock if the company suddenly gets hit with massive lawsuits, spirals toward bankruptcy or faces other cataclysmic obstacles.
But it’s not going to happen with broadly diversified mutual funds or exchange-traded funds, which have increasingly become investment mainstays. To lose everything in an index fund pegged to the Standard & Poor’s 500 index, for example, each of those 500 companies would need to go belly up for you to lose everything. That just isn’t going to happen.
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Most likely, you will just give back some of your gains accumulated during the previous, long bull market. During the past 12 bear or declining markets dating to the Crash of 1929, investors lost 42% on average, according to J.P. Morgan Asset Management. Conversely, they gained 164% on average during bull markets, which also endure for more than twice as long on average.
Bear markets are a normal part of the long-term cycle, but bull markets are more powerful, tilting the odds heavily in the favor of long-term investors.
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A deep recession isn’t a certainty
As a rule, stock prices rally when the economy is strong and expanding, and they fare poorly during economic downturns. A lot of that has to do with the profit cycle, as good economic times are more prosperous for most companies, with favorable news such as solid job growth and rising consumer confidence.
Right now, many investors are understandably worried that the coronavirus outbreak will slow business activity to the point that it tips the economy into a recession, defined as two straight quarters of negative economic growth. Stock-market gyrations are considered a leading economic indicator — that is, something to watch for clues on where the economy might be heading.
But sharp stock-market reversals don’t necessarily presage recessions. Nor is it a certainty that the next recession will be severe. The most recent economic downdraft from 2007 to 2009 — the one that sticks in everyone’s memory — happened to be the second-worst of the past century. The next one, when it arrives, could be relatively mild and of shorter duration.
The person next to you likely doesn’t know more than you
A big reason the stock market has been so unstable lately is because of uncertainty. The health and economic ramifications of the coronavirus still aren’t totally clear, even to professional investors, and that gives rise to a lot of speculation and fear. Many people are assuming the worst. Unusual, surprising developments — like Italy announcing a countrywide quarantine or the outbreak being declared a pandemic — can feed into that.
Just don’t assume somebody in a dark tower somewhere knows any more than you do about how the future will unfold. Consequently, you shouldn’t spend a lot of time listening to — or pay much attention to — television pundits trying to predict the future, let alone your neighbor or the Uber driver who just gave you a ride.
In many ways, this inability to foresee the future accurately is something that evens the investment playing field. In other words, we’re all in the dark right now, and the light will be revealed to us gradually, at the same time.
Uncle Sam is ready to share your pain
The income-tax system should be viewed as an ally at times like now. If you realize losses — meaning you sell something to lock in a loss — you might be able to deduct some of that against ordinary income. At a minimum, you can use realized losses to offset any realized gains that you take (assuming your investment is held in a taxable account as opposed to a tax-sheltered 401(k) plan or Individual Retirement Account).
Plus, you have leeway to time your tax decisions to maximum advantage. Neither the government, nor anyone else, will force you to sell at any particular time.
Speaking of IRAs, you might consider converting a traditional IRA to a Roth IRA, from which no future taxes will be due. You must pay taxes on the balance you move over when converting to a Roth. But after market slides, your accrued gains — and thus your potential tax bill — is lower than where it had been.
As another consolation prize, you might be receiving a subsidy to invest, which should make it easier to accept occasional losses. In most 401(k) retirement plans, employers kick in anywhere from a few hundred to several thousand dollars a year in matching funds. View this free money as a cushion against losses.
Your portfolio maybe isn’t all that risky
Nobody likes to see those big red numbers flash on the TV screen, showing the stock market racking up massive daily losses. But chances are, your portfolio isn’t going down nearly as much in percentage terms, as most investors complement stock holdings with bonds and cash, which provide cushion during downdrafts.
One way to check is to evaluate your portfolio’s “beta,” which measures sensitivity to market gyrations. You do this by dividing the percentage change for a market indicator such as the S&P 500 and comparing it to the percentage change in your portfolio over the same period. Suppose the S&P 500 falls 10% in a week while you suffer a paper loss of 5%. You would have a beta of 0.5, implying that your portfolio is only about half as volatile.
If the market keeps dropping — and you don’t make any changes — your beta and portfolio riskiness will decline further, because your stock holdings will represent a smaller slice of your portfolio. Hence the potential wisdom of rebalancing or diverting new money to stocks or stock funds after a big drop, to raise your equity holdings so that you will have more punch for the next, inevitable bull run.
Reach Wiles at [email protected] or 602-444-8616.