After more than a decade of tremendous gains in the stock market SPX, -1.59%, just about everybody in the financial advising business knew that a correction of some sort was due.
It was anybody’s guess as to when or why. The news of the coronavirus spreading outside China’s Hubei province has turned out to be that catalyst. Stocks, unsurprisingly, have sold off.
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The coronavirus is deadly and the headlines from China about frontline medical workers becoming victims are heartbreaking. Nevertheless, the job of a prudent investment manager is not to speculate about short-term events.
Rather, the job of advisers is to help clients by making sure in advance that their investments are properly balanced between stocks and bonds. If they are, sharp turns in the market tend to play out without triggering an unnecessary and damaging emotional response.
Read: Coronavirus fears are clobbering the stock market — is it doing the same to your retirement?
It’s that emotional reaction that can easily lead a client to bail on perfectly good investments. Yes, some might feel a little better by selling with the crowd, but inevitably they come to regret letting bad news chase them out of good stocks.
Do you think the trustees of the world’s great endowments, the people running massive public retirement funds in big states such as California and other experienced professional investors are panicking and selling because of the coronavirus?
No way. Many of them, in fact, likely are buying stocks as they fall. They understand that news events, what traders call “headline risk,” are short-term factors that distort true market valuations.
I realize it’s hard to think long term like a pension fund administrator. That’s why the steady hand of a good financial adviser can be helpful. Here are a few thoughts that I hope calm you enough to avoid making an emotional decision with your portfolio.
First, how are you invested? Do you own actively managed mutual funds or individual stocks? Are you following a recent investment fad? Hopefully not. Owning low-cost index funds that reflect the entire global economy suggests you’ll be more than fine.
The global economy has always recovered from calamities such as the tech bubble, the Great Recession and so on. In any five-year rolling average period since 1950, a portfolio of stocks and bonds has seen positive returns.
Specifically, J.P. Morgan JPM, -4.80% data show that stocks fell by 13.8% on average each year since 1980, yet they ended those years with gains three-quarters of the time. Going back to 1950, a 60/40 stock-to-bond portfolio returned 8.9% on average through 2019. It’s hard to argue with success.
If you are 50 and worried about your IRA or 401(k), remember that you can’t withdraw money without paying taxes and a penalty until you are nearly 60. Do you really think that in 10 years your IRA will be worth less than it is today? Invested properly, your money at a 7.2% compounding return will double over those 10 years. At a 6% compounding return it will double when you reach 62.
Unless you’re retired and need income now, cash is an automatic loser as investment. Not only is inflation eating away at your money, it’s virtually impossible for cash to compound in a bank account paying nearly nothing in interest.
If you are living off your retirement money now, what percentage of your entire portfolio are you spending each year? If it’s between 3% and 4%, it’s likely that the dividends you collect will cover your financial needs. You’ll be fine as we ride this out.
If you still believe your gut instincts will help you avoid the short-term pain of a market decline, remember this: To win you have to get two decisions right, when precisely to get out and when precisely to get back in. If you get one of these wrong it likely will cost you dearly down the road.
Most people who choose to get out rarely get back in on time and consequently they miss big moves up. Princeton professor Burt Malkiel, a member of the investment committee of my firm, puts it this way: “I’ve been around this business for 50 years and I’ve never known anyone who could time the market, and I’ve never known anyone who knows anyone who could time the market. You can’t do it. It’s very dangerous.”
Additionally, if you have your money in a taxable account, selling will trigger long-term unrealized gains, so you’ll take a tax hit no matter what.
We all wish that we had a genie that could predict the markets. Many folks you see on the financial news channels certainly claim genie-like abilities. But the truth is no one can.
In the absence of that genie, we believe in rebalancing a portfolio is the next best thing. Your investments already churn cash back into your accounts all year long in the form of bond interest payments and dividends. Typically that cash flow is reinvested best by reinvesting automatically at a low cost.
Over time, of course, your preferred ratio of stocks to bonds can get out of whack. Rebalancing forces you to sell high and buy low systematically, no matter what’s happening in the headlines. It’s the only real way to capture gains year in and year out without having to bet which way the market will go next.
If you’re due to rebalance soon, go ahead and keep that virtuous cycle going. Ignore the headlines meanwhile. Too often, they will only do your retirement irreparable harm.
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