Lower Prices Can Be Beautiful
It’s hard to find a silver lining in the midst of our current public health crisis, and we hope that you, your family and your friends stay healthy during this challenging time. But we also hope that you respond to the dropping stock market in a constructive way.
What does that mean?
First, it’s usually a mistake in the long-term to sell your stocks during a bear market. Doing so locks in losses and can leave you unprepared to recoup your losses when the market turns around. (History shows that the market will turn around. It is impossible to predict precisely when.)
The problem is most severe if you are near or in retirement. If you fall into this category, hopefully, you already adjusted your portfolio to be reasonably balanced in a way that reduces your exposure to risk.
Stocks have always recovered from bear markets, recessions, even depressions. Keep in mind that the current swoon differs from most, in that the cause wasn’t a problem in the economy. Couple that with the market’s ever-upward long-term trend, and most people who won’t retire for many years have the opportunity to use the current low stock prices to buy bargains.
Stocks Go Up
If you examine the historical record, it would be quite the exception to see stocks in negative territory over long investment horizons. For most broad market indices, stock returns have not been negative for any 20-year period stretch of time. It’s not that surprising, as the economy and corporate profits tend to grow along with the population. You can participate in this growth by committing some percentage of your investment assets in a well-diversified stock portfolio. Diversification reduces your exposure to losses from any one company or sector, although it won’t magically protect you from the short-term pain of a bear market.
However, the fact remains that stocks tend to overreact to news, good or bad. For example, the Dow fell 18 percent in October 2008, much more than the GNP drop during the subsequent recession. The market recovered fairly quickly and went on to new all-time highs.
The COVID-19 pandemic looms large right now. But it’s unrealistic to think that it will remain so in five or 10 years. There is no reason to think that the economy won’t recover from the crisis-induced coma caused by social distancing requirements. The stock market anticipates the future, which means if you sell now and plan to buy stocks when things start getting better, you will likely be too late to enjoy the full benefit of the recovery.
Dollar Cost Averaging
In general, trying to time these market swings is folly, leading to mistakes in timing and higher costs for the stocks you ultimately own. The better approach is typically to buy more shares when prices are low. You can accomplish this with Dollar Cost Averaging (DCA).
The idea behind DCA is simple. After deciding how much new money you’ll invest in the next 12 months, you then divide the amount equally into 12 monthly purchases. The result is that you’ll buy fewer shares when prices are high and more shares when prices are low. The effect is that your average cost per share will be lower than the 12-month average prevailing price per share when you complete your investment. That mathematically assured result compares very favorably to any random attempt to time the market.
Everyone’s situation and risk tolerance is different, so it’s wise to discuss your specific situation with a financial advisor you can trust.
Bumping Your Investment Rate
Unless you are the rare exception, your investment assets have likely declined in value during this COVID-19 bear market. However, contrary to your natural instincts, it may not be the best time to make any radical adjustments. In fact, for many people, it may make sense to increase your investment rate each month.
In down markets, stock prices are basically on sale. The money you may be saving by staying home and not going out can be used more productively by allocating the funds to your retirement plans and to current savings. Bumping up your investments can have a positive effect that will pay off with the passage of time.
Also consider the historic low interest rates available right now from cash savings and bonds. While you may want to sock away four to six months of expenses in an emergency fund, bond prices are high right now (bond prices rise when interest rates fall) while stock prices are low, and possibly going lower. This means it may be a good time to revisit your asset allocation.
For example, you might have allocated 60 percent to stocks and 40 percent to bonds. In light of the current conditions, it may be a good time to consider taking on a little more risk. That might mean resetting your asset allocation to 65 percent stocks and 35 percent bonds by re-directing some of your bond investment into stocks. By using DCA, you can accomplish this without timing risk.
It takes discipline to buy stocks when everyone else feels panic. Panic is not a strategy. If you can control your fear, you can mitigate the worst of the current environment while strengthening your retirement fund.
How We Can Help
Linscomb & Williams has been helping busy families with their financial planning needs for nearly 50 years. Needless to say, we’ve seen many different market situations. We’ve also seen what can happen when trying to time the market and the damage that can come from making emotional investing decisions.
It’s easy to think investing is simple when markets are good. But it’s important to stress-test your investments to ensure you’re in the right position should a downturn occur in the market. No one can predict the future. But having the right asset allocation can help put you in a better position to weather any storm.
These are unprecedented times, for sure. The Linscomb & Williams team is here for you.