Fueled by fears related to the Coronavirus and compounded by a drop in oil prices, the US stock market has exhibited extreme volatility over the past several weeks. While double digit corrections are not unusual, this has been an historically abrupt decline.
When you hear about stock market risk, this is it. It is the risk that shows up that no amount of analysis or forecasting could have predicted with any degree of precision or reliability. This is why diversification is so important and planning before the risk shows up is crucial. As investors, our willingness to bear this risk is how we earn a higher return than we might if we kept all of our retirement savings in a savings account at the bank.
Even though we know that these risks can show up, it still feels unnerving as it’s happening, especially when the media uses words such as “plummet” and “panic” and “sell-off”. To help provide some perspective, consider the following:
- Some are calling what we have been experiencing over the past few weeks a “panic”, but perhaps a more useful description is a “price adjustment”. In other words, prices are adjusting to reflect the fact that there has been an unexpected increase in the chance of a recession due to the Coronavirus and its implications. While describing the stock market decline in this way may not grab people’s attention in the way that other headlines might, it’s probably closer to the truth.
- If the risk of a recession is higher, then why own stocks? Well, you wouldn’t want to own stocks unless you were compensated for doing so. The lower prices we are seeing are the markets way of offering investors higher expected returns going forward and encouraging investors to buy stocks and stay invested.
- Some investors may be tempted to “get out until things get better”, but the problem with this strategy is that by the time things look better, prices will likely be much higher. It’s impossible to costlessly unload your risk on to some other investor (if you are selling, someone else is buying) after the risk has already shown up. Diversifying, planning for the risk before it appears and staying invested is the better approach.
- Speaking of diversification, as stocks have declined in value over the last few weeks, high quality bonds have increased in value. Diversification works.
- If you are a younger accumulator, our advice is to keep investing on a systematic basis, whether the market is up or down, and in ten years and beyond you will be glad you did.
- For retirees and pre-retirees, this is where planning comes in. A sound retirement plan anticipates the ups and downs we have been experiencing and incorporates this variability into the plan. Ideally, you should have multiple years’ worth of cash flow needs invested in less volatile bonds so that you do not find yourself in a position where you are forced to sell stocks at an inopportune time just so you can pay your bills. While your time horizon may feel short, keep in mind that retirements are typically decades long.
One thing that is certain is that the future is uncertain. But the prescription to get through any period of uncertainty is to return to the fundamentals: control what you can, remain diversified, monitor spending, and keep costs down. Once that is taken care of, you can focus on the more important things in life.
Speaking of, we wish everyone the best as we all learn how to deal with the spread of this virus. We are hopeful that the costs in human lives are kept to a minimum, and we are optimistic that we will adapt as needed and overcome whatever challenges lie ahead. In the meantime, take care of yourself and your family and stay healthy!
