Amid the stock market downturn this week, many people are asking two questions:
“How bad will it get?”
“How long will it last?”
While no one can answer these questions, I do have an answer to a third question: “What should I do?” Below are seven observations and recommendations to consider through this period:
1. Ask any financial advisor what they recommend at a time like this, and most will offer the same advice: “Don’t panic.” While I agree, that doesn’t mean there’s nothing you can do. Especially given the length of the bull market since 2009, it’s easy to have become complacent, so I would use this as an opportunity to check in on your investment strategy. I’m a big believer in stress testing, and that’s exactly what I recommend. Ask yourself what the impact would be if the market continued going down from here. Between 2000 and 2002 and again between 2007 and 2009, the U.S. market lost about 50% of its value, so that is a good starting point for stress testing.
2. If, after conducting stress tests, you determine that there’s too much risk in your portfolio, you shouldn’t feel that it’s too late to make a change. If you sell some stocks now, you are by no means violating the investment dictum against selling low. Far from it. Though the S&P 500 is down 13% from its high last week, it is still 7% above where it was just a year ago.
3. This period of market stress also provides an opportunity to observe the power of diversification in action. You can see it at two levels. First, the performance of bonds over the past week illustrates why bonds are, in my view, the most effective tool for diversification. Though the yields are paltry, and in some cases no better than a savings account, bonds can do something that cash can’t: rise in value. Over the past ten days, while the S&P 500 has lost 13%, an index of intermediate-term Treasury bonds has gained 2%. You can also see the importance of diversification within the stock market. Year-to-date, the S&P 500 is down about 9%, but there’s a lot going on within that 9%. Among the eleven industries that make up the S&P 500, some are faring much better than average. Utilities, real estate and technology companies, for example, have experienced only modest losses, on the order of 4-5%. Meanwhile, energy companies are down a wrenching 24%. This is why I always recommend diversifying using stocks and bonds, and why I think the best stock market investments are total market index funds that own stocks in all eleven industries.
4. If you’re still in your working years, and saving from every paycheck, then these events shouldn’t bother you. In fact, counter-intuitive as it may seem, you should see this as a positive development. While no one likes to see the value of their savings decline, market downturns should be seen as a benefit if you are a net saver. In fact, if you’re early in your career, you should be hoping for a prolonged downturn during which you can buy stocks at cheaper prices. Folks who are older—myself included—may not take joy in this fact, but it is true.
5. Many of the headlines I’ve seen this week have been in ALL CAPS, with all kinds of dramatic statements: markets tumble, pandemic risk rises, fastest decline ever, yields collapse, and more. If you’re reading these headlines, recognize that news organizations don’t gain readers by speaking calmly, so don’t be too rattled by what they’re saying. Also keep in mind the classic study demonstrating that more information doesn’t necessarily lead to better decisions. So don’t feel that you need to watch the news 24/7 at times like this.
6. A few weeks back, I talked about the danger of narratives. People love to tell stories—because they’re more interesting and easier to remember than facts and figures. That is especially true at times like this. With this coronavirus being new and not well understood, everyone can paint their own picture. Some are pointing out that it is far less deadly than the flu that comes around every year, while others are focusing on the higher mortality rate. Some say that this couldn’t possibly be as bad as the Spanish Flu because our medical care is better than it was in 1918, while others counter that air travel, which has more than doubled over just the past fifteen years, causes disease to spread more widely. My advice: Beware of all these stories. While there is a kernel of truth in each of them, no one knows exactly how they will impact your investments, especially in the long term.
7. While no one knows exactly how bad things will get with the coronavirus, I recommend consulting past market downturns to gauge the potential impact on financial markets. And here’s what history tells us: Since World War II, there have been twelve bear markets during which the stock market fell more than 30%. On average, it has taken two years for the market to recover—sometimes less and sometimes more, but never more than five years. Right now this all seems scary, so it’s important to maintain perspective.