As you know from all the shrieking TV stories, the stock market fell sharply last week. It was a take-no-prisoners plunge. You weren’t safe in the U.S. market. You weren’t safe in Europe. You weren’t safe in Asia. You weren’t safe in the emerging markets.
Someone pulled a plug and more than 10 percent of all market value went down the drain. Some market darlings did far worse. Beyond Meat (ticker: BYND) dropped 20.3 percent. Tesla (ticker: TSLA) fell 21.4 percent.
So what should we do?
My answer: Don’t just do something — sit there!
This is one of those times when absolute passivity pays off. And it pays off for different reasons depending on whether you are young or old. This is not a philosophical statement. It is a practical statement.
Let’s start with retired people.
We’re the ones who depend on our investments to provide much of the cash to cover daily living expenses. If you were a Couch Potato investor and had half your money in the U.S. stock market and half in the U.S. bond market, a portfolio that had been worth $100,000 at the beginning of 2019 would have risen 19.76 percent to $119,755 by the end of December. It would have had $54,420 in the bond fund and $65,335 in the U.S. stock market. Investors with a similar allocation between stocks and bonds will also have had a good year.
So guess what? You had an automatic sell signal.
To rebalance back to 50/50 you would have needed to sell $5,457 early in 2020 and invest it in the bond fund. So you would have taken some of your gains off the table.
No crystal ball required.
If you take required minimum distributions, the math would be a bit more complicated, but you would still have ended up taking market risk off the table.
“O.K.,” you say, “But what about next year?”
Well, it’s not so bad. Suppose markets go from bad to worse and stock prices fall another 10 percent. They drop a tough 20 percent by year-end. What then? Well, even if bonds provide virtually no return, your portfolio will be down by “only” 10 percent. If your investments provide half of your retirement income, which means you’ll have 5 percent less spending power next year.
To be sure, cutting spending by a few percent isn’t easy, but it’s not the Great Depression, either.
As a practical matter, the hit won’t be quite that much if you’re old enough (over 72*) to take required minimum distributions. Why? Because each year the required distribution rate rises a bit. From age 70 to 71, for instance, the increase is 3.3 percent from the previous year.
The bottom line here is that unless you’re certain that global civilization is headed for total liquidation, you’ll be OK.
Now consider young workers.
If you’re still saving, opportunity just came knocking. The only thing better than buying stocks over a long period of time is being able to buy them at cheaper prices when the market has a crisis of confidence.
Don’t take my word for it.
This is what Warren Buffett has said many times, including early this week on CNBC.
Few had the nerve to do it, but the best buying opportunity in this century wasn’t at a market top. It was in early 2009 as the market headed for its bottom in March. While few have the cash or nerve to pile in at an exact market low, every retirement account investor will pick up bargains simply by continuing to invest, month by month, in a qualified plan.
Is this a teaching moment?
For some, this decline may be a “teaching moment.” They will learn what their real risk tolerance is. We all have a high tolerance for risk in rising markets. We only learn our true risk tolerance in sinking markets.
Some people draw the line at losing anything. Others are OK with a 5 percent loss. Some can take a 10 percent loss in stride. But the behavioral economists have shown that virtually all of us suffer greater pain with losses than we enjoy pleasure with gains.
If you’re losing sleep, it probably means that your tolerance for risk is less than you thought it was. In that case, this market correction has done some of the risk adjusting for you by decreasing the percentage of stocks in your portfolio. Pay attention.
In the long run, everything gets better
Pessimism is routinely taken as the mark of a truly serious and deep person, but I believe what British historian T.B. Macaulay said nearly two centuries ago is as valid today as it was then:
“We see in almost every part of the annals of mankind how the industry of individuals, struggling up against wars, taxes, famines, conflagrations, mischievous prohibitions, and more mischievous protections, creates faster than governments can squander, and repairs whatever invaders destroy.”
That, in due course, will include the COVID-19 invader.
Correction: an earlier version of this column listed the age to start required minimum distributions as 70 1/2 but it is now 72, changed by the SECURE in late 2019.
Related columns:
Scott Burns, “Falling in love with required minimum distributions,” 6/29/2019 https://scottburns.com/falling-in-love-with-required-minimum-distributions/
Sources and References:
Jason Derrick Benzinga, “Warren Buffett on Monday’s Market Plunge:’That’s Good For Us’, 2/24/2020, CNBC https://finance.yahoo.com/news/warren-buffett-mondays-market-plunge-180842393.html
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Valdemaras D. from Pexels
(c) Scott Burns, 2020