Courtesy Charles Weeks
Certified Financial Planner Charles Weeks.
- The coronavirus has shaken up markets and left investors wondering if they should sell or stay put.
- As a Certified Financial Planner, I can tell you the best thing you could have done with your money by now is simple: left it alone.
- When you're feeling panicky, review your financial plan and investment strategy and remind yourself why you've made certain choices.
- SmartAsset's free tool can find a financial planner to help you take control of your money »
The coronavirus pandemic has caused ceaseless fluctuations in the market, prompting many investors to wonder what they should be doing with their money. As a Certified Financial Planner, I can tell you the smartest thing you could have done with your money by now is simple: left it invested according to your investment strategy.
I realize how difficult that sounds. In normal 10% market corrections we fight ourselves not to react emotionally, but during greater-than-30% drawdowns because of a global pandemic, it feels impossible not to sell, right? Well, not exactly, not if we have the right tools in place to help us combat those negative emotions.
Review your financial plan first
The first thing we should look at when we are feeling scared because of a big market selloff is our financial plan. Our plan should describe the proper amounts of insurance coverage we require, how much we need to hold in cash equivalents for our emergency fund, the amount needed in savings or less risky investment vehicles, such as CDs or short-term bonds, for our short-term financial needs, and how much should be invested for our long-term financial goals.
By reviewing this before panic-selling we will hopefully find that we don't actually have anything to worry about. If we have the correct amount in emergency savings, we can feel comfortable knowing that even if we were to lose our jobs, we have three to six months of our expenses covered.
Also, by properly allocating money into money market accounts, CDs, or short-term bonds for our spending needs over the next two to three years, we don't become forced sellers at the worst possible time, a market panic. It is OK if our longer-term investments have lost value, even a lot of value, because we won't need to tap into that for years.
I can't tell you exactly when your portfolio will regain its previous value, but I can tell you in the Great Recession it took a 60% stock, 40% bond portfolio about three years to recover and a more conservative 40% stock, 60% bond portfolio took just over two years.
Pay careful attention to your investment strategy
Within our financial plan we should have a well-defined investment strategy. For most, this is simply an asset allocation that spells out how much should be invested in each asset class, for example 60% in stocks and 40% in bonds.
However, the more detailed we can get here the better. It would be worthwhile to construct an investment policy statement (IPS) that not only describes your asset allocation but also includes things like your risk tolerance, past performance of similarly allocated portfolios, how often the account is reviewed and rebalanced, and what investment philosophy or strategy is used to manage the funds.
In the midst of daily market drops, it can be helpful to review how a similarly allocated portfolio performed during past crises. While past performance does not guarantee future results, and history doesn't exactly repeat itself, it can be surprisingly similar.
So, is it normal for your moderate portfolio of 60% stocks and 40% bonds to be down over 20%? Well, in 2008 a similar portfolio was down around 20% for the year, even worse from the peak portfolio value in October of 2007 to the trough value in March of 2009, it dropped over 30% in value. By reviewing market history and its impact on various portfolios, we can better understand that volatility will always be part of our investing lives and therefore not a sign that we should act radically.
As part of our IPS, we should list how often we review the portfolio, usually annually but can be as much as quarterly. I can tell you it should absolutely not be daily, which is exactly what most people do during a crisis.
We also should set targets for rebalancing our portfolio - we want to make sure we stay within a range of our original asset allocations. You may be surprised to learn your portfolio is now 50% stocks and 50% bonds because stocks lost so much value. Instead of selling out of your stock positions, we should actually be rebalancing into stocks. This forces us to sell high and buy low, the exact opposite of what most people do during times like this.
Finally, having a defined investment strategy will prevent us from chasing fads or turning into day-traders. For example, by knowing you invest only in a well-diversified portfolio of exchange-traded funds, you won't feel compelled to buy that beaten-down pot stock your neighbor is talking about or that triple-levered volatility short ETF your pizza delivery guy is raving about. In personal finance, success is sometimes determined by simply avoiding the big mistakes.
The bottom line
Let's finish with this: If you didn't follow your investment strategy and you have sold your investments, it's OK, you'll live. We may have further to go on the downside, which will give you an opportunity to re-invest those funds. However, we may have hit the bottom, which means you must have a plan for when you will get back into the financial markets.
I suggest picking some objective factor, it could be the Volatility Index dropping below a certain number, the S&P 500 price-to-earnings multiple reaching its historic mean, or could be when the number of new COVID-19 cases in the United States begins to level off. Whatever you choose it is important you get back in and in the future don't allow yourself to make the same mistake again.
As Abe Lincoln once said, "If you make a bad bargain, hug it all the tighter." It is OK to make mistakes, but we must remember them and learn from them.
Want help with your money? SmartAsset's free tool can help find a qualified professional near you »
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