With the high level of volatility that global markets have experienced over recent weeks, you may be asking if there is a threshold at which we would recommend selling investments and waiting on the sidelines for markets to settle down. Essentially, does it ever make sense to hit the pause button on a long-term investment strategy in order to wait out short-term market sell-offs? It is natural to have questions like this when you look at your portfolio and see account values dropping every day.
Our advice is two-fold:
1) Make sure that you have a cash flow plan in place that is expected to provide for your needs for 10 years; and
2) Leave the rest of your investments to work in the long-term strategy.
Let’s explore why this advice stands even in unsettled times. First, we will revisit why we recommend planning for 10 years of cash needs. Stocks have produced positive returns in 95% of all historical 10-year time periods. In instances where losses did occur, they averaged less than -1.6% annualized. With a well-crafted cash flow plan, you should have little to worry about in a stock market decline. If you are not forced to sell stocks to meet cash needs, then you will be in a position to hold on for future gains.
OK, fine. But, if it is obvious that the stock market is in freefall, then why not let it fall further and buy back in at a lower price? The simple answer to this is that we never really know where the bottom will be or how quickly the recovery will come. Most of the time, declines entail little more than a 10% – 15% correction. As is illustrated in the chart below, you may be surprised to know that this sort of correction occurs nearly every year. Why don’t you remember most of them? Because most declines recover quickly and are a distant memory by December when the results for the year are finalized. Sometimes the sell-offs do gather steam, dropping 20%, 30%, or even 50%. (We have seen 50% sell-offs two times since the turn of the century.) However, the honest truth is that we never know exactly how deep or long each sell-off will be because we are unable to see the future.
One thing that we do know is that historically some of the best days in the market are in extremely close proximity to the worst days. If you move to the sidelines to try to avoid the worst days, then you are also very likely to miss most of the best days. The events of the last few weeks serve to illustrate this dynamic. Note the following dates and corresponding headlines:
March 12 – Stocks plunge 10%. Worst day since 1987.
March 24 – Stocks rise 11%. Best day since 1933.
Less than two weeks apart we were witness to very dramatic extremes. The roller coaster feeling of this sort of movement is terrible, and we sincerely wish that this was not the way markets work, but the reality is unavoidable. One must ride through the dips and feel that terrible sinking feeling in their stomach in order to be rewarded with the climb back up.
To further illustrate this concept, I recall a national news anchor opening the nightly news in late 2008 on the day of a sizeable market drop with the question: “Is it finally time to go to cash?” The market had already lost 44% of its value and was within 8% of finding its bottom just a few months later. Anyone who took the advice of that fear-driven statement likely lost out on 2009’s dramatic recovery.
Another very important thing to recognize is that the stock market usually bottoms out long before the bad news stops rolling in. Markets are anticipatory, always looking to the future and trying to gauge the impact of current events on future financial results. Once it seems that bad news is well understood, the markets will start to look beyond it. Death rates, defaults, and company failures are likely to peak after the stock market actually hits the bottom of its slide.
Hopefully this discussion provides context for why we recommend staying the course with your investment portfolio, even during an exceptionally turbulent time. There is no question these markets are unsettling. At times like this, it is extremely helpful to keep in view the lessons that we learned via difficult experiences in past downturns, as well as by studying historical downturns. This is the simple truth that stands out: Sometimes it gets really bad, but with history as our guide, it will get better.
As always, If you are feeling uncomfortable in any regard, please reach out to us. That’s what we are here for.
Paracle Personal Financial Management is an independent financial planning firm founded in 2004 with an honest desire to help people optimize their finances by providing unbiased financial planning and investment advice that puts their clients first. Paracle specializes in delivering expert, comprehensive wealth management services to busy families. Their expertise integrates financial planning with investment management to ensure their clients experience confidence in every aspect of their plan so they can focus on what matters most. To learn more about Paracle, connect with them on LinkedIn.