COVID-19 has changed our lives. Social contact, work, family, school, going out to eat, and online meetings are just a few of the things that have changed. But should it cause us to change our investments?
Some of you have had and survived COVID-19. Others have lost loved ones to the virus. Some have sold the stocks in your retirement plans or, at the very least, seen the value of those plans drop significantly.
Essentially, We've had our lives turned upside down. Whatever certainty and control we thought we had is gone. Uncertainty often leads to fear. Fear causes many of us to do things we would not normally do.
There is a constant drumbeat from mainstream media pushing out stats on new cases, deaths, job losses, restrictions on what we can and can't do, and predictions of an economic collapse. It's exhausting!
With all of the negativity continuously thrown at us, it's much harder to find good news and remain positive.
Amidst all of this, there are some things we can count on. If you're an investor, I submit to you that your investments are one of the more reliable things. That may sound crazy. But it's true.
What follows are my top five reasons why your investments should NOT change after getting past the COVID-19 pandemic.
Table of Contents
Reason #1 – Markets Are Predictable
If we look at the long term history of the stock market, we see a predictable pattern.
Source: Dimensional Fund Advisors
The chart above shows the market returns from 1926 to the end of 2019. Is it a straight line? No. Is there a pattern of predictability? Yes – consistent long term growth of investor capital.
The problem for investors is only a small percentage stay the course to achieve the long term returns available to them. Carl Richards, often called the sketch guy, calls this the behavior gap.
The behavior gap sketch shows that investor returns lag investment returns over time. Fear and other factors cause investors to move in and out of their investments rather than staying invested. For those who remain invested, the behavior gap is much lower, meaning investor returns get much closer to investment returns.
The chart above confirms that this is true. Investors who ignore the short term ups and downs of the market, no matter how dramatic, get rewarded with higher returns.
Reason #2 – Timing Does Not Work
I know the traders out there will vehemently disagree with that statement. But the evidence is irrefutable.
Look back at the last two significant market drops – 2000-early 2003 and the 2008 financial crisis. In the tech bubble of 2000, several got it right. A few lucky pundits happened to predict the crisis. Far fewer did in the 2008 crisis. After the crisis was over, those who followed the “winners” who got lucky with their market call, got hammered following their advice going forward.
It reminds me of the old saying, “even a blind squirrel finds an acorn once in a while.”
Many investors look to Morningstar for research on investments. Morningstar is famous for its star rating service.
Every year, they apply a fund rating to thousands of stocks and mutual funds from 1-star to 5-star. The 5-star funds are those that have performed the best in the past. Most people look at the 5-star rated funds over the previous year. Many invest in those funds for the following year.
However, the data show that the 1-star funds outperform the higher-rated funds. Read this Investopedia article for a detailed discussion. Past performance is rarely a good indicator of what will happen in the future. It's a subtle form of timing that many investors use. And it doesn't work well.
Reason #3 – Diversification Does Work
Why is it important? Because if all of your investments are moving in the same direction at the same time, you have much more risk than you probably realize. More importantly, it's impossible to predict which assets will perform the best year to year. Most of you have probably seen some version of the chart below that validates that statement.
Source: Dimensional Fund Advisors
Having a broadly diversified global portfolio offers exposure to stocks, bonds, real estate, and other asset classes that can reduce investment risks and position your portfolio to capture returns no matter where they come from.
That has always been true and will continue to be true during and after the coronavirus fades.
Reason #4 – Emotional Decisions Are Usually Bad Decisions
Does anyone think they make the right decisions when they are emotional? I know I don't.
Psychologists tell those in the midst of a divorce should not make any significant decisions for at least a year. The same advice goes for those who lose a loved one.
Another example is physical and emotional abuse. That behavior comes out of anger. Nothing good comes out of decisions made with outsized emotion.
That goes for investment decisions too. In every significant market downturn, too many people decide to sell their investments at the worst possible time. The decisions come out of fear. Looking at your investment statements and seeing them drop quickly and dramatically is alarming for sure. The best thing to do during times like that is to ignore your investment statements.
Turn off the financial news (or all news for that matter). Take a break from the hysteria.
Is This Time Different?
Though today's news is different than during the financial crises of the past, it is still exaggerated and sensationalized. The good news doesn't sell. Fear does. It's kind of like passing a car accident along the highway. You see traffic lined up and can't understand why. As you drive a bit further, you see the ambulance and police lights and realize there's an accident. You know you shouldn't look, but you can't help yourself. Neither can the rest of the drivers. That's the reason for the backup.
Emotional selling is no different. You know you shouldn't do it. But when fear enters the picture and gets fed by the news or conversations with coworkers, family, or friends, it sometimes causes us to do things we later regret. Selling during market downturns is a perfect example.
Check out the cycle in the chart below and see if it doesn't make sense.
Source: Dimensional Fund Advisors
Rebalancing your portfolio at least once a year should be the only change you make.
Reason #5 – Goals Matter
If you aren't investing with a specific goal in mind, it will be hard to measure or succeed. Goals come in lots of forms. Are you investing for retirement or your kids' education? Perhaps you're trying to reach financial independence before you retire. Maybe you're trying to create other sources of passive income.
Unless the reasons you're investing have changed, there's no reason to change your investment portfolio. Think about it. If you built your portfolio to help achieve a long term goal, unless your plan has changed, neither should your portfolio. Just because the market isn't behaving the way you want it to this month, this quarter, or this year, it doesn't mean you should make changes to your investments (see reasons #1 and #4). That's how investors get into trouble.
If your investments do not connect to a goal or a purpose, maybe it's time to change that. Staying focused on a goal makes it much easier to keep the plans you've made to achieve that goal. That not only includes your investment, but also spending, saving, and managing debt. All of these things should be analyzed together when working toward a goal.
The five reasons listed here are not new ideas. However, in times like we find ourselves now, they can act as a reminder to help us stay on track.
For the most part, I'm an optimist. I believe things work out for the best. Life doesn't come with a guarantee that it will always be good. I know of no one who gets through life without some wort of significant crisis. To some extent, we are all going through a crisis that is not of our own making. Things going on feel surreal. That feeling can bring on fear. Fear is a powerful emotion.
Let's use history as our instructor during these times. Our country endured multiple health crises over the years – smallpox, cholera, H1N1, H2N2, HIV, and now COVID-19. The lesson we can learn from this – we got through them. Past is prologue is a saying that still applies. Another great one is “if we fail to learn from the past, we are doomed to repeat it.” Let's not let these become tired old cliches. They have relevance to us today as they have in the past.
This article is about investing. Patience and discipline are virtues when investing. They are also virtues in life. As a kid, I hated it when my mother would say to me, “this too shall pass.” However, as an adult, I embrace it. We will get through this crisis like we have all of the previous ones.
Do your best to stay the course. History tells us you will get rewarded for your patience.