The Market Just Crashed! What Should I Do?
As I write this post, the Dow Jones Industrial Average has just dropped 1,000 points – the sixth 1,000 point move in the last 12 days. The Dow and the S&P 500 are 13% below their most recent high, well into correction territory. The interest rate on 10-year Treasuries, a safe haven in times of market turmoil, has dropped to a record low 0.7% — substantially less than inflation and only slightly better than stuffing your money in a mattress. (The interest rate on Treasuries, as with all bonds, is inversely related to its price. As panicky buyers bid up the price, the corresponding interest rate is driven down.) The Fed just announced a ½ percentage point cut in the interest rate it charges banks – an emergency stimulus that, thus far, appears to have had little effect.
Why is the stock market taking a nose dive?
What’s causing all this sturm und drang? The coronavirus, aka COVID-19, is the culprit for the current swoon. With over 100,000 cases and 3,000 deaths in multiple countries (the vast majority in China), this new (to humans) virus is bidding fair to become the next worldwide pandemic. After about a month of watching China struggle to contain the virus, cases began cropping up in South Korea, Japan, Iran, Italy and elsewhere. The world realized that this virus was becoming a true worldwide scourge. The stock market reacted accordingly, beginning a series of dizzying gyrations – mostly free falls, but also some up days when relative optimism made a brief comeback.
Why should the coronavirus affect the stock market? A certain amount of the reaction is simply fear and uncertainty about how severe the virus’s impacts will be and how long they will last. But real economic effects are also starting to be seen: airline traffic and other travel have dropped precipitously, factories are shuttered and workers furloughed (at least in China). Big companies like Apple have warned that their supply chains have been disrupted and their production and profits will suffer in the months ahead. Schools are closing down or going online, restaurant traffic is plummeting, and those who can are working from home. Increasingly, people are canceling travel plans, avoiding public places, and hunkering down. Some economists are predicting a recession. It’s no wonder the stock market reflects these worries.
To anyone who has a significant amount of money invested in stocks, this sudden market downdraft is unsettling, to say the least. If you’re in retirement, or close to it, it could cause anxiety or even outright panic, as you watch your hard-earned savings go up in a puff of smoke and, perhaps, your dreams of a comfortable retirement threatened. So – what should you do?
What can you do?
The best advice for most people is to take a deep breath and… do nothing. It’s never a good idea to make significant financial moves while feeling pressured or panicky. If you had a well considered long-term investment strategy before the sudden correction happened (and you shouldn’t be holding stocks unless you are investing for the long haul), nothing has fundamentally changed that should cause you to pull your money out of stocks and put it somewhere safe (such as a Treasury note yielding 0.7 percent??). Most of those who pulled their money out of stocks during the 2007-2009 Great Recession missed out on the long bull market that followed, during which the average stock rose nearly five-fold. The instinct to run to safety can do far more financial damage than the bear market itself.
The best advice for most people is to take a deep breath and… do nothing.
A little historical perspective may help to keep your focus on the long-term picture. Market corrections (declines of 10% or more in a major stock index, such as the S&P 500) are a regular (although not predictable) characteristic of the stock market. Since World War II, there have been 26 market corrections in the US, with an average stock value decline of 13.7%. The corrections typically lasted about four months, and full recovery took another four months. Bear markets (declines of 20% or more) are less frequent but more severe. In the 12 bear markets since WW II, stocks have declined an average of 32.5% over an average of 14 months, with recovery taking another two years. In the most recent bear market, from October 2007 to March 2009, the value of the S&P 500 dropped 57%, recovering in four years. In late 2018, we came within a whisker of another bear market. Some – but by no means all – bear markets were accompanied by a recession (two or more quarters of contraction) in the real economy.
While this is certainly a lot of negative movement in the stock market, the overall trajectory is actually up – returns on stocks over the last hundred years are about 10% per year (7% after inflation), despite the fairly frequent downdrafts. To realize these long-term gains, though, you have to weather a lot of volatility. The graphic below shows the long-term increase in stock market value over the last 70 years, despite all the bear markets and recessions along the way.
You likely knew all this already. The only problem is, it’s different when the volatility is causing your hard-earned savings to disappear before your eyes.
What if it gets worse?
What if the current correction is just the beginning? Wouldn’t it be smarter to cut your losses and get out now? Probably not. Most corrections and bear markets occur for a reason. During such times, there are plenty of financial gurus pointing out the negative forces weighing on the market and the economy, and providing advice consistent with the current gloomy outlook. The virus is still spreading and will bring the world economy to its knees. The stock market is overvalued and ripe for just such a trigger to bring on a bear market. The virus is the last straw that, added to trade wars and massive refugee movements, will bring on the recession that we all know is overdue. The arguments are usually plausible, and the dire predictions may indeed come to pass. But if you look around, you’ll find a roughly equal number of experts suggesting that “excess valuation” has been wrung out of the market and this might be a good time to “buy on a market dip.” The truth is, nobody really knows whether the market is going to go down further or bounce back.
Suppose you’re lucky or clever enough to get out at the right time. How will you know when to jump back in? How likely is it that, having managed to protect your savings from the ravages of the Great Recession, you would have the vision and steely resolve necessary to buy back in in March of 2009, with the financial system on life support, unemployment at 10%, mortgages under water everywhere, and the Dow at 6500 – less than half its value of a year and a half earlier? Trying to time the market is a fool’s errand, which is why the best advisers recommend that you create a financial strategy and then stick with it. It’s deceptively straightforward, but can be hard to do when all is doom and gloom around you. Still, it’s good advice. Take it from these investing luminaries:
“Wise investors won’t try to outsmart the market. They’ll buy index funds for the long term, and they’ll diversify.”
— John C. Bogle
“Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they’re going to be higher or lower in two or three years, you might as well flip a coin.”
— Peter Lynch
“For most of us, trying to beat the market leads to disastrous results… our actions lead to much lower returns than can be achieved by just staying in the market.”
— Jeremy Siegel
“The only value of stock forecasters is to make fortune-tellers look good.”
— Warren Buffet
Isn’t there anything I can do?
Is there really nothing to be done when the market plummets and takes a chunk of your nest egg down with it? I do have a few suggestions. First, try to avoid checking your account balances frequently when markets are in turmoil. Watching the train wreck happen in real time will only increase your anxiety. Behavioral finance tells us that losses and gains are not emotionally equivalent; losses inflict more pain than gains provide pleasure. Distract yourself by taking a hike or reading a good book.
Second, if you have a target portfolio allocation and recent market gyrations have taken your holdings significantly astray (say, you desire a 60/40 stock/bond split and recent events have taken you to 50/50), it’s reasonable to think about making adjustments to get yourself back to your desired state. It’s best to have a strategy for when and how you rebalance – usually either (1) a set time (say, once a year in late December), or (2) whenever your portfolio deviates from your desired state by more than a certain percentage. Don’t start making ad hoc portfolio moves, and don’t do anything if you’re feeling panicked. Just take a deep breath and wait until you’re calmer.
Finally, if a market correction makes you anxious enough that you’re losing sleep, it might be time to re-evaluate whether your portfolio allocation is appropriate for your age, temperament, and circumstances. Try this thought experiment: imagine the stock portion of your portfolio losing half its value (roughly what happened in 2007-2009). For example, a 50/50 portfolio would go down in value by 25%. How would you feel? Would you become despondent or depressed? Would you worry about running out of money in retirement or needing to make big changes in your standard of living? If the answer is yes, it may be time to reconsider how much of your portfolio is devoted to stocks. While you likely need some equity exposure for growth, you might be happier with less than you’ve got. But again – don’t make any big changes under stress. Think it over, discuss it with your partner, talk to a financial adviser if you have one you trust, and review your financial plan. Run some numbers through financial calculators to see how robust your strategy is. Wait until your serenity returns before making significant portfolio adjustments. (If you don’t have a financial plan or a investment strategy, it’s time to create them. You’ll feel much better when you have. You can get started with this post.)
So, what should you do in a market correction? Stay cool, keep your eye on the big picture, and don’t shoot yourself in the foot by making ill-considered moves to ‘protect’ your investments. Oh, and don’t forget to wash your hands frequently.
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