This year we’ve talked a lot about the impact of 2020’s current events, especially the COVID-19 pandemic, on our clients and on the market. Now that we’re halfway through the year, and the U.S. is still dealing with the effects of the pandemic, we wanted to offer some lessons learned. We’ve had conversations with many clients over the past few months to help them navigate the financial markets during the pandemic, their concerns and possible future actions to take.
Based on these conversations and the questions clients have been asking, we put together a conversation between a hypothetical couple, Ron and Pam, and their advisor. If you’ve asked yourself any of these questions, you’re not alone.
Ron: There’s just so much negative news about the economy and unemployment rates, and now the virus is breaking out in some states again. I feel like we should maybe get out of the market for a while until things settle down.
Advisor: We can certainly look at lowering your allocations to stocks if that helps give you some added peace of mind. However, you are already in a moderate allocation, and we don’t want to get too conservative since you both can expect to live a long time yet.
We also don’t want to just get out of the market. One thing we are seeing constantly is that timing the markets doesn’t work. Just look at how fast they have come back up from the low in March. Timing the markets is just making a bet in one moment of time about future events. One of the worst mistakes an investor can make is thinking they are so sure of a certain event occurring in the near future that they have to get entirely out of the stock market.
Think about all of the investors who sold their stocks in March and April because they felt they needed to get out and about how all of those investors will now try to get back in the markets at higher levels. It will likely take them a very long time to recover their losses, if they are able to do it at all. Unfortunately, we see this cycle repeat itself when there is this kind of downturn. It can be very difficult to stay the course during market downturns, but you never actually have real losses unless you sell.
Ron: But I don’t understand how the markets have recovered so quickly given some of the bad economic news. I feel like the markets are going to go back down again.
Advisor: Markets could go back down again. As you have heard me say before, we have to accept and even embrace the uncertainty that comes with investing in the stock market, even when uncertainty gets very uncomfortable. Keep in mind your rewards are coming from dealing with that uncertainty and volatility by earning potentially higher rates of return in the stock market than risk-free cash. There is no free lunch or silver bullet — if you want higher returns, you must generally accept more risk.
One of the biggest lessons we have been reminded of in this recent experience is that markets are always looking ahead and trying to value businesses over the next few decades based on the available information, not just the next year or two. While that may sound obvious, the timeline of recent events provides some evidence of how quickly this can happen.
First, the markets reacted aggressively down when the seriousness of the virus became more readily apparent and economic shutdowns first hit. However, as more information became available about the virus, and with the significant stimulus and other actions by the federal and state governments, the markets began to believe that at least another great depression likely would be avoided. Then, markets started to look past 2020 and into 2021 and beyond, and there was a growing confidence that economic activity would be much better on the other side of this valley. Add in some promising news about possible vaccines, and the market jumped.
The amount of government stimulus or relief in all of its forms is unprecedented. One of the lessons we learned now and from 2008-2009 is that the Federal Reserve and government have the ability, at least for a while, to flood the system with a lot of liquidity, which gives support to financial markets.
Now, have we come too far too fast? Maybe, but again, no one knows for sure, regardless of what we may be feeling.
Ron: But then we hear that all of this stimulus and low interest rates could lead to inflation and market bubbles and ….
Pam: I think he is saying that that’s the kind of stuff we need to learn to ignore!
Advisor: That’s right. Thanks, Pam!
Think of it this way. The U.S. stock market has averaged roughly 10% per year since about 19281. Since then, we have been through every kind of market situation possible: depression, world wars, social unrest, high inflation and so on. You two have lived through some of this! One of the lessons is that we could pick just about any day during that time and come up with a bunch of bad things going on around the world that might make it feel like a bad idea to invest on that day. This is certainly true today. Yet markets have worked through all of those events, pricing in the ability of businesses to produce profits in any environment and generating significant returns over time.
Investing is not gambling. It’s not a game where we hope to get lucky with a lottery ticket. It’s about owning shares in companies around the world whose goal is to generate cash flow and wealth over time. Investing is a process for the long term. When markets are down, we rebalance, often buy more stocks and sell losses for the tax benefits. When markets are up, we want to sell areas of the market that have done well and buy other areas that haven’t done as well, expecting they will eventually recover. This disciplined process keeps the risk and expected return of your portfolio in balance, and hopefully allows the portfolio to recover more quickly after downturns.
I really think we have information overload. There is so much information available on a day-to-day basis that we can easily get distracted from the big picture. One of the lessons we should learn from this is that we believe a well-constructed financial plan, that includes a cushion for short-term and medium-term cash needs, is built to withstand difficult market performance over the course of a few months.
If there is one piece of advice I could get you to follow from this meeting, it would be to stop looking at your portfolio results every day. I know that’s easy to say and hard to do! But that’s why we have these types of conversations where we can answer your questions, work through your concerns and provide reassurance that we’re still on the right track.
Pam: So, given everything that’s happened, are we in the right mix of investments? What else do we need to know?
Advisor: Given your age, financial situation and specific objectives, your portfolio has to be balanced to provide good returns on the upside and some cushion on the downside — understanding that it’s often impossible to predict what the next thing might be that sends the markets into a decline. This means you may give up some return when the stock market is going up, but you get some cushion when the stock market is in decline. Think of it like a car: The stocks are the gas pedal, and the bonds are the shock absorbers. You need both for the best experience. The key is to find the right balance for you.
It’s easy to want to chase the latest fad, especially when you see some stocks in a hot sector do well for a while. But an event like this brings people back to the fundamentals: well-balanced global allocation that is appropriate for you, tax-sensitive and low-cost. Focus on what you can control, keep enough cash for your short-term needs, understand your own risk tolerance and let the markets work over time.
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