Equity has been volatile recently, seesawing all over the place but mostly trending down. You don’t have to be an investment legend to know that it’s rarely wise to be a seller in such environments if you can avoid it.
Selling into a downturn violates one of the key tenets of successful investing: selling high. And investors who panic-sell are prone to make emotional decisions that undermine the success of their plans. Even the emotional relief that selling might bring is fleeting, as it’s so often quickly replaced by another nagging worry: Is it time to get back in?
For all of these reasons, the admonition to stay the course in a falling market is often sound advice. Unless…
Reason 1: You ignored rebalancing all along.
Not touching your portfolio presupposes a few key things that may or may not apply. The biggie is that it assumes the underlying investment plan and asset allocation are well-thought-out and well-tended.
Until recently, we were living in an era of FOMO, fear of missing out, in which many novice investors barreled into risky assets with the hopes of overnight riches. It’s a big leap to assume that many of these newbies were operating with an underlying plan or even an appreciation of investing basics like asset allocation, diversification, and the role of time horizon.
And even investors who did have a plan at one point in time may well have found themselves unmoored from it. A portfolio that was 60% in equity and 40% debt a few years ago could have been 72% in equity and 28% debt at the start of this year. Yet getting investors to peel back on a winning asset class in favour of one with a dinky yield (cash and bonds) is an uphill climb.
Many investors’ natural tendency is to do nothing with their portfolios for years, especially when the market is marching steadily upward. The path of least resistance beckons.
So there could be a reason for investors to lighten up on equity during the current market downdraft, even though the conventional wisdom is to do nothing.
Reason 2: You’re getting close to retirement and need to de-risk.
As I’ve interacted with older adults over my career (and, have gotten older myself), it has dawned upon me that even as our comfort level with risk-taking usually grows, our ability to absorb risk usually diminishes.
I think that explains why it’s so tough to get older investors to de-risk their portfolios in the years leading up to and in retirement. They’ve seen this movie. They know stocks usually recover, and their stocks have beaten everything else in their portfolios by a big margin. The big losses that stocks endured during the dot com crash and the Great Financial Crisis have been erased. Is it any wonder that so many older investors are standing pat with equity-heavy portfolios?
Yet even as risk tolerance grows with experience, risk capacity--the ability to absorb big losses in our equity portfolios--declines as we get close to drawing from our portfolios. At that life stage, it’s wise to begin building out positions in cash and bonds as a bulwark.
If a lousy market materializes early in retirement, the investor can “spend through” the safe stuff versus tapping depreciating equity assets. In our recent research on in-retirement withdrawal rates, we found that balanced portfolios generally supported higher withdrawal rates than more equity-heavy ones.
Reason 3: You have a short-term investment goal.
New investors have been flooding into the market during the pandemic, thanks to strong gains on stocks and other assets as well as the fact that many individuals have extra time and cash to invest. Research in 2021 from investment firm Charles Schwab found that these newbies have a median age of 35 and their incomes are about $20,000 less than investors who were in the market pre-pandemic. Half of the new investor group--what Schwab calls “Generation I”--are living paycheck to paycheck. A healthy share of the new investor group was expecting to hit big lifetime milestones within the next few years, such as buying a home or having a baby.
Those statistics suggest that some new market entrants are not laser-focused on amassing investments for their retirements in 30 or 40 years. Rather, they may need to tap their portfolios sometime soon to cover an emergency expense, tide them through job loss, or fund some shorter-term goal like a house down payment. If they need to get out of their stock investments at an inopportune time, they could lock in losses.
Today, new investors who find themselves with too risky portfolios should feel absolutely no shame in liquidating some of their equity holdings in favour of a portfolio mix that adequately reflects their potential need for liquid assets within the next few years.
Reason 4: There’s a chance you’ll capitulate if things get worse.
The preceding two situations relate to risk capacity, where a too-aggressive portfolio might be at odds with someone’s spending horizon. In other words, their spending goal dates could force a liquidation at an inopportune time (or even worse, force them to change their goals and plans).
But even if an investor has an adequately long-time horizon to hold stocks, there’s another issue that can crop up with too-risky portfolios, and that’s capitulation risk. That’s my own term, referring to the chance that the investor could become so nervous during periods of losses that he sells himself out of stocks, thereby turning paper losses into real ones.
For investors who have found themselves inordinately spooked by the recent market volatility, it’s wise to use it as a wake-up call to make some changes, even if their portfolios’ equity exposures seem right on paper. After all, recent market losses are minor relative to the depth and duration of some previous market downturns.
(The S&P 500 lost half of its value in the bear market that began in March 2000, for example, and that bear market was a grinding one, lasting 31 months. The bear market that ensued during the great financial crisis was quite a bit shorter, just 17 months, but the losses were an even sharper 56%. In other words, if the recent market volatility has you spooked, you ain’t seen nothing yet.)
While throwing stocks overboard won’t make sense, lightening up on stocks while adding a bit more to debt and cash just might.
Investors might use their response to the recent market action as an impetus to delegate their portfolio management to a professional adviser. Doing so can help reduce the worry, ensure a situation-appropriate asset allocation, and help protect the investor from his or her own worst impulses to trade at inopportune times.
