In late December of 2018, the S&P 500 had declined approximately 20% from its September high, people were panicking about trade wars and rising US interest rates, and fear-inducing headlines like these were being published:
“U.S. Stocks Post Worst Year in a Decade as the S&P 500 Falls More Than 6% in 2018”
“Dow, S&P 500 Post Worst December Since 1931, as Nasdaq Has Worst on Record’
Not long before that, we published a post that explained how normal stock market volatility is and how unextraordinary the market pullback was in a historical context. Considering the headlines and current events of the time – and following a 10-year bull market – there were plenty of logical reasons why the stock market should continue declining in 2019. In fact, this sentiment was shared by many investors as December set a record for monthly withdrawals from U.S. stock funds.
However, almost as if scripted, when the new year began the market abruptly reversed trend and rose dramatically throughout the first half of 2019. In fact, the S&P 500 increased a whopping 19% during the first six months of the year. The “worst December since 1931” ended up marking the bottom of a temporary correction, and those investors who pulled a record amount of money from U.S. stock funds missed the subsequent rally that brought the market to its current all-time high level. Ouch.
When the stock market is declining, it’s tempting to want to sell and experience the temporary satisfaction of feeling safe. However, most investors fail to look ahead and ask themselves when they will get back in if they do sell? Of course, “when it feels better” or “after the market goes down a little more” aren’t good answers, especially since there’s no magic bell that rings when the market is at the bottom and by the time the news headlines are positive, the market will have already recovered dramatically. Many of those investors who sold at the end of last year are still sitting on the sidelines waiting for that perfect time to get back in…all while dealing with the frustration and regret of having missed out on a huge investment return this year.
Over the course of only six months, the question for most investors has changed from “What should I do about this declining market?” to “What should I do now that the market is at an all-time high?” Investing at an all-time high can be difficult, especially after the U.S. stock market’s 10-year run and with no shortage of media narratives about how the market has gone up too much for too long, it’s become too expensive, it has to pull back eventually, etc.
In reality, the market could continue going up or a bear market could start tomorrow. Nobody knows. What we do know with near certainty is that at some point there will be another correction or bear market. The problem is that no one can predict when it will happen or how long it will last.
The point here is that there will always be stress and uncertainty with investing. When the market is going up, you’ll wish you had more in stocks. When the market is going down, you’ll wish you had less in stocks. Mistakes happen when investors try to time the market or speculate about what to do next based on headlines or emotion. The legendary investor, Peter Lynch, summarized the problem well when he said, “Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the correction themselves.”
What You Can Do
The good news is that you don’t need to predict where the market is going or pick the next Amazon to have a great investment experience. Just as there are things you can do when the market is experiencing a temporary pullback, there are also things you can do after the market has experienced a large gain as it has this year. Here are three R’s to consider:
1) Rebalance Your Portfolio
Rebalancing is the process of bringing your portfolio back to its original investment allocation by selling some of your holdings that have performed best and buying more of your holdings that have performed worst. Rebalancing is a way to buy low and sell high in a disciplined manner, without trying to speculate or time the market. Periods of strong performance by a particular region, in this case the U.S., often present opportunities to rebalance a well-diversified portfolio that owns both stocks and bonds across the globe.
2) Revisit Your Goals
Have your goals changed? Have you moved closer to the point when you’ll need some of your investment money for certain goals, such as college or a home down payment? Perhaps you are now in a better position to meet some of your goals and can afford to take some risk off the table by investing less in stocks.
3) Reflect on Your Investment Temperament
How did you feel during December of 2018? If you were an investor in the 2008 financial crisis, what was that experience like? If you experienced significant stress during these periods, and you can meet your goals with less stock exposure, you may want to reconsider your investment allocation. The time to make a change is when things are going well, not during the middle of the next pullback.
However, if your goals haven’t changed and you’re comfortable with the amount you have invested in stocks, now is the time to remain disciplined. Just as it’s important to maintain a steady hand when the market is falling, you also want to avoid getting swept up by emotions or extrapolating current performance when the market is rising.
Not every stock market correction and subsequent rebound illustrates the behavioral mistakes of the average investor as clearly as what we saw during the past year. However, history shows that investors consistently make decisions based on their emotions, whether the emotion is fear when the market is declining or greed when the market is rising. And these emotional decisions explain why the average investor underperforms his or her own investments over time.
To have a successful investment experience, it’s important to remain disciplined through both declining markets and rising markets. We know there will be more corrections and bear markets in the future, but trying to time these pullbacks or letting emotions guide your decision making is how serious investment mistakes are made. By taking the time now to rebalance your portfolio, revisit your goals, and reflect on your investment temperament, hopefully you can be more confident and better equipped to handle the next pullback, whenever it comes.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.