It seems clear that the posturing and bickering spectacle in Washington which resulted in kicking the deficit can down the road, followed by the Standard & Poor’s “vote of no confidence” downgrade of longer-term U.S. debt, badly frightened many investors.
Never mind that, until the recent drama, the U.S. markets were in positive territory for the year. Never mind that there seems to be no purely economic reason for the selloff. After all, corporate profits are still high, the U.S. economy is recovering (albeit more slowly than some of us would like), and consumer balance sheets are greatly improved over three years ago.
This appears to be a classic emotion-driven downturn, made worse by a breathless media that always seems to amplify the mood of the moment. History has shown that these times of panic are dangerous to long-term returns; they are fundamentally an urgent invitation to sell at a market bottom. Fearful investors are strongly tempted to give up their seats on the roller coaster to somebody with a clearer head and stronger nerves.
The challenge for financial planners is to reassure clients that the roller coaster is safer than it was last time. For the past two years, I’ve promised you markets with greater volatility and another crash. I’ve also discussed ways for you to prepare for it.
If you took appropriate action without panicking, you—like perhaps 90% of investors—are in better shape than ever to weather this crash better than the last. Here’s why:
• Your portfolio is slightly more conservative. After the recovery, we lowered equity allocations for some clients. We will be buying more equities in portfolios once a market is down 20%.
• You’ve already gone through, and survived, two market crashes since 2000.
• Hopefully, you took some money off the table. For many retirees, we created a cushion of cash sufficient for one to five years of spending. This protects them against having to sell when markets are down.
• You’ve taken advantage of the recovery of the past two years to diversify your portfolio among asset classes. You’ve committed to staying with your investment philosophy and rebalancing at least quarterly. During the last crash, 77% of our clients made no changes at all to their allocations. Of the 23% who did, most made relatively small changes, such as reducing equities from a 70/30 to a 60/40 or a 50/50 allocation.
Ironically, some of the investors most vulnerable this time around are those who panicked during the last downturn and insisted on selling some or all of their stocks near the bottom. Those who sold are worse off now than those who stayed in, because they missed out on the market recovery. Logically, it might seem that very painful lesson would make them the most likely to stay invested and ride it out this time.
Unfortunately, the human brain doesn’t necessarily work that way. The remembered pain of the previous experience is more likely to increase the fear of the current experience, even to the point of triggering a “sell out now” panic.
For those of us who hate roller coasters, hurtling downward at breakneck speed is the scariest part of the ride. It’s also the worst possible time to jump off. We’re far better off, even if we keep our eyes shut, to hang on tight. And breathe.