What Do I Do with the Recent Stock Market Crash?
The market turmoil of the past couple weeks has brought out all forms of pundits, financial pop-media, and others who make their living off of scaring investors that the next great depression is upon us and they should make massive changes in their finances.
While I have no idea if 2020 will be the next major financial meltdown I do know how you should react to the recent news. React by revisiting your long-term financial plan (assuming you have one) and not attempt to change your plan in light of temporary conditions.
Joshua Escalante Troesh, CFP | MBA
For perspective, here is the article I wrote in 2018 in response to the last “the sky is falling moment.” As an encore: here are the 6 things you can do to keep the market crash from ruining your financial plan.
1. Verify if Your Portfolio is Constructed Properly
If you created your portfolio based on how the stock market was doing at the time, then your investment allocations are likely wrong. Portfolios should be built based on the probabilities of returns over the entirety of the investing time period and not on what has happened recently. Said another way, you should build your portfolio based on the idea you will experience both market growth and market crashes over a multi-decade investment period. What this means is a properly constructed portfolio will have already anticipated a market downturn like this one as part of the long-term expectations of the financial plan.
My clients’ financial plans expect downturns like this, which means even significant market corrections (what many call crashes) are already factored into their plan when determining if the portfolio will allow them to achieve their goals. Good portfolios will be broadly diversified not just across many different companies and industries but also across multiple types of investments and throughout world economies. While some investments have taken a beating lately, others are on the rise, reducing the impact of the recent bear market on the overall portfolio.
While the market turmoil of the past two weeks may seem significant, it is well within the variance thresholds I use when creating financial plans and constructing portfolios. As a result, the market turmoil should not have an impact on long-term goals and actually present potential planned buying opportunities as part of a long-term investment strategy which anticipates both bear and bull markets.
2. Don’t Do A Damn Thing
Assuming your portfolio and financial plan is constructed correctly, the next thing to do is to ignore what is going on and execute the plan in place. Market downturns happen and an investor is going to experience up to a dozen market downturns over their entire investing life.
For your retirement accounts, if you are not nearing or in retirement, don’t react to a market downturn which will honestly have zero impact on a properly developed investing plan. Even if you are in retirement the market downturn should have been anticipated and already been factored into your financial plan.
No matter how grave the situation may seem, don’t fall into the temptation of reacting to short-term market movement by changing a well-thought-out financial plan. Instead, stick with the plan and ride out these seemingly important but ultimately inconsequential market drops.
Even the 2008 credit crisis would have had no impact on an investor who stayed the course of a proper plan. In 2009 the SPY S&P 500 stock index lost 1/2 it’s value from it’s high in 2006; dropping from around $174 to around $70. Those that did nothing were rewarded over the next decade with a 300% gain from the low in 2009.
Doing Nothing Beats Market Timing
Those who are dialing back their investments in the stock market, or who are fully moving to cash, are practicing a method of investing called Market Timing. The idea is simple, you sell investments right before a market crash. The problem is, one would have to be incredibly arrogant or gullible to believe they (or anyone else) have accurate knowledge of the future.
When looking at the math of market timing, the math overwhelmingly favors those who ignore the news and do nothing with their investments. William Sharpe, a Nobel prize winning economist and a distinguished Professor of Economics at Stanford, conducted research on comparing the mathematics of market timing verses simply staying in the S&P 500 and doing nothing.
Sharpe found a market timing strategy had to be right 74% of the time in order to simply match the returns of an investor who did nothing. Meaning, unless you think you will accurately predict when the market will drop (in order to sell investments) and also accurately predict when the market will rise (in order to buy investments), then you will earn more money by doing nothing.
Those who actually do try to predict the direction of the market are wrong more often than they are right. Essential Advisor Research studied experts in technical analysis and market timing (those talking heads you see interviewed on the news). What they found was the experts were correct only 47% of the time.
3. Consider the Source
Be very careful of where you get your information from and whose advice you take. The media does very little to vet sources for long-term accuracy, and often the more outlandish and bold the expert’s predictions are, the more the media flocks to them. Simply because outlandish and bold predictions help attract an audience. These experts are simply the P.T. Barnums of the modern era.
Two such experts are Murrey Gunn and Peter Schiff who regularly predict market crashes - including a massive market crash in 2019 when the stock market rose almost 30%. Both Gunn and Schiff are well-known chicken littles who profit from scaring people into buying their respective investment strategies to 'protect against market crashes.' In reality, their investment strategies actually do little more than make Murrey and Peter rich.
Gunn’s and Schiff’s bad predictions go far beyond the recent ‘mistake.’ On October 12, 2016 Gunn asserted “With the US stock market selling off aggressively on 11 October, we now issue a RED ALERT.” In the 2 years after that "RED ALERT" the S&P 500 went up 28% (14% return per year) and continued to climb into 2019.
Following Schiff would be just as bad, as he continually pushes the collapse of the economic system in order to make profit selling gold investments to the investing public. Schiff's amazing predictions include a 2012 prediction that Gold was going to rise to $5,000 by 2014. At the time gold was sitting around $1,700 an ounce. In reality, the price of gold crashed by 24% shortly after the prediction, and is currently sitting at $1,574 per ounce.
Don’t Believe Anyone’s Crystal Ball
Anyone who tells you they know what will happen in the market should be roundly ignored. And that includes me if I ever make such a stupid assertion. I'm not saying a market crash can't happen, but managing the risk of market corrections should be based on strategies rooted in academic research that create a consistent multi-decade plan. Not rooted in guesses of what will happen to the market over the next year or two.
4. Get Some Perspective
March’s market drop may seem like a huge deal, as the S&P 500 dropped from $3,370 to $2,500 in a matter of a couple weeks - over a 20% drop. And while it is a significant drop, it should be expected to happen occasionally based on the historical record of the stock market.
While the market could fall further, don’t think the recent drop guarantees anything in the future. To put the drop into perspective, the stock market drops by 10% on average once every year (357 days). And according to Standard & Poor’s research, the average annual drop in the market (from peak to trough of a single year) is 14.2%. So a 20% drop, while much larger than average, shouldn’t be viewed as a guarantee of any future declines (or a guarantee of the opposite - a recovery).
5. Don’t Be So Short-Sighted
Stop managing your money as though your plan is to die soon. Ultimately, reacting to the current market changes assumes you don’t have time to outlast whatever financial storm might come. Your investing success is determined not by what happens in the next few years, but by what happens in the next few decades. Even retirees have multiple decades of retirement to plan for, so being overly concerned about the returns of any single year (or couple of years) is a bad idea.
The following two graphs will tell you everything you need to know about why the last couple weeks don’t matter to your final investing success.
How 15 Days Looked
When looking at the stock market returns as represented by the S&P 500 over the two weeks, the drop looks downright scary. The problem, of course, is the chart offers no perspective of history.
Instead of showing the history of the market, charts like this show a brief snippet in time. Often, showing a chart with such a short time frame is done to intentionally spin the truth into something else.
For you personally, looking at a chart like this will give you a misleading view of what is happening. A view which then might lead you to make mistakes with your investments. Instead, you should match the length of the chart to at least half the length of your investing timeline to get a more accurate picture of what the market declines means to you personally.
How That Same Month Looks Within 15 Years
If we pull our timeline out to look at the last 15 years, however, the recent drop doesn’t look so bad. Additionally, when putting the market decline into longer-term perspective it becomes easier to see how a bear market like this can be factored into a multi-decade financial plan.
Interestingly, this time perspective even includes the massive crash of 2008/2009. But from this perspective, that crash looks more like a blip than a catastrophe. Of course, if you decided to sell your investments in the stock market even before the market crash happened, you have lost out on a lot post-crash returns. Sadly, there are many who are still waiting for the right time to invest after the market crash of 2009.
6. Don’t Confuse a Bull Market with Brains
One of the worst things you can do as an investor is to assume the success of someone’s investing strategy (or your own) is due to their intelligence. Over the past decade, the stock market has increased massively with very little volatility. This consistent growth has led many active investors to think it is their amazing analysis of buying and selling at the right time which caused the increases in their portfolio. In reality, however, they likely lowered their potential return due to minor mistiming and increased fees.
A researched-based investing strategy doesn’t involve timing one’s way into or out of the market. It involves setting a long-term strategy based on achieving your goals even though market declines and crashes are inevitable. And constructing a portfolio that invests in broad asset classes with low correlations to each other. Not in guessing what the stock market (or any other asset class) might do tomorrow.