GUIDING PRINCIPLES
Current volatility is frequently representative of imminent volatility. The word volatility is often (incorrectly) used interchangeably to describe market downturns. But it's just a statistical measure about deviations from an average. Consider that if the stock market goes down 20% every day for 3 days in a row (welcome to hell!), then it's volatility – or how much the data points differ from the average – is not high. It's the lowest possible volatility number...0%.). Market downturns almost always have days and weeks of both large downturns and large upturns, and that's why they can be described as volatile. Calibrate your expectation for large swings both ways in the coming weeks, and you won't be surprised if it happens.
Market prices already reflect probabilities of future outcomes. Investors should not describe issues that the world already knows about, and assume they have not been calculated, considered, and embedded into prices already.
It's okay to be disappointed, but it's not okay to be surprised. If you use an advisor, and are surprised by your returns, it's time for a hard conversation. Clients deserve appropriate expectations for their investment journey, and part of that will be occasionally disappointing market returns.
The market is never “going down” – it only has gone down and may go down further. Remember that three weeks into the Covid-19 downturn, the market pivoted, screamed higher, and never looked back. Research on market recoveries tells us 3 critical things: (1) downturns have always recovered, (2) expected future returns over the next few years are higher after a downturn than before a downturn, and (3) markets are brutish and irreverent, and will not wait for you to get your shit together.
Economic data lags market prices. It wasn't until October, 2009 that jobs data improved following the Great Financial Crisis, but the stock market bottom was seven months earlier on March 9, 2009. Markets are anticipatory and love making fools out of investors who are waiting for economic signals.
Be like Naomi Hasegawa. Read (or reread) this piece. I wrote it during a market upturn almost three years ago, and it's probably the best writing I have on how to actually be a great investor. The same principles hold during a market downturn. Investors have one job.
How you do anything is how you do everything. This is a guiding principle for our firm's approach to client service, but it's also a fantastic reminder about the slippery slope of unnecessarily increasing your trading and portfolio activity. If you start to dabble in being unsystematic during downturns, and acting on opinions and hunches, recognize that you will likely keep doing it (if you're wrong, incentivized to gamble more and recoup losses; if you're right, incentivized to mistake luck for skill...and press on it). It's an abyss. I've seen it so many times. Live a big life of spontaneity outside your portfolio, not in it.
The market does not care about your opinions. Stop it. Just stop it. Empirical studies on environments like this remind us that we don't know. Goldman Sachs doesn't know. Morgan Stanley doesn't know. UBS doesn't know. I don't know. You don't know.
THE BLUEPRINT FOR SUCCESS
Improve the reliability that your portfolio will capture an eventual market recovery. Historically, downturns have always ended, but similar to how they start, we can never know precisely where or why. If you want to increase your reliability of capturing a recovery, don't buy single stocks when the market goes down. Don't buy single sectors, or even single countries. Buy broad human ingenuity to solve whatever problem our world is facing, in as many investable corners of the universe as possible. The appropriate benchmark (i.e. the index list that a fund would track, or attempt to beat, if it was a global fund) for this approach is the MSCI All Country World Index IMI (not the S&P 500!).
When it comes to stocks and bonds, methodically buying what's relatively gone down and selling what's relatively gone up DOES makes sense. If your portfolio has been designed with your ideal life in mind (i.e. taking enough risk to live the life you want, and avoiding unnecessary risks that won't accomplish this), then part of implementation is rebalancing. If you are targeting a 60% stock and 40% bond portfolio, and a stock market downturn causes you to be 50% stocks and 50% bonds, then you should strongly consider going back to your target weights. Buy low, sell high, because the baseline of these descriptions has been informed by what you are trying to accomplish.
When it comes to countries, regions, or sectors, methodically buying what's relatively gone down and selling what's relatively gone up DOES NOT make sense. The weights of assets in the world are unrelated to your ideal life. If after Trump's inauguration, the U.S. now makes up less of the global stock market as it did before (true), or energy stocks are now less of the market than other sectors (true), it does not mean to solely buy more U.S. or energy stocks because they're cheaper. The market just re-weighted things for us – it's a new environment, and the old environment is no longer relevant. Take guidance from prices: U.S. and energy stocks aren't as great as before. Do not buy low, sell high, because the baseline of these descriptions is not an appropriate reference point anymore.
This is a great time to reassess how you've designed your portfolio. If it has become a collection of random investments over the years, rather than a thoughtful and philosophically-based design and process, let a downturn and the opportunities it presents be the impetus for a better approach.
Consider tax-loss harvesting. Capital gains tax is annoying, but the government will reward you with the opposite (a tax on them) if you sell positions at a loss. Work with an investment expert to find positions at a loss that can be sold and closely mimicked with extremely similar positions, but which the I.R.S. would classify as technically different. Capital losses (via harvesting) never expire, can offset capital gains (now or in the future), and additionally $3,000 each year of capital losses can offset your annual income (meaning, if you make $100,000 per year from your job, the government will only tax you on $97,000). If that sounds sort of silly, I agree. But money is money.
Consider Roth conversions. If you have pre-tax money in a Traditional IRA, it has a future tax liability attached to it. Downturns present an opportunity to potentially convert that Traditional IRA money to Roth IRA money, and remove the future tax liability by paying it now (it's most beneficial, on expectation, to do these when prices are low...hence why a useful consideration during a downturn). Work with a financial professional to consider if it may be worth paying upfront taxes now to pay less expected taxes over your lifetime.
Consider getting out of individual stocks. The long-term, positive average of the stock market does not come from each stock giving you a little bit of return. It comes from most stocks doing terribly and a handful delivering ungodly returns. Buying individual stocks, from a research perspective, is a subpar decisions with subpar expected outcomes. Of course it's possible that it works out well, but that doesn't mean it's likely. If you have individual stocks at a loss or with gains you can offset by other losses, this might be a great time to evolve your approach.
Consider getting out of crappy, tax-inefficient, expensive funds. The investment world has evolved. If you are still using mutual funds in taxable accounts instead of more tax-efficient ETFS, or have legacy positions that are high-cost or dated, consider similarly to sell if at a loss, or take a gain that can be offset with other losses from your portfolio.
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Downturns can be frustrating, but they present unique opportunities to improve your investment process and portfolio design.
Whenever the market eventually recovers, you'll be glad you did.
End.