Every year around this time, I meet clients for end-of-year financial planning meetings. I love these meetings. I get to see some of my favorite faces (though almost entirely on Zoom this year), and the conversations we have often uncover new planning opportunities. Happily, that has been as true this year as ever. What’s different this time around, however, is that so many people have asked me this:
“Is the market going to crash?”
It’s not a new question—or a new fear—but it has certainly been more prevalent during this wild last half of 2020. My response, often, is a question of my own: “Why are you concerned about this?” What I hear next are answers such as “I heard the market is overvalued,” “I’m concerned if Trump is re-elected,” “I’m concerned if Biden is elected,” or “the pandemic will cause the economy to fail.” If you, too, find yourself feeling anxious and worrying about the myriad reasons the market might crash, take a deep breath, and read the words I share with concerned investors like you:
Even the worst ‘crash’ hasn’t caused permanent damage.
If the market does ‘crash,’ are you worried that recovery will take 3 years? 5 years? 10? Since World War II, the average bear market (meaning a market that is down 20% or more) has lasted 14 months. Market corrections (meaning the market is down 10%-20%) have lasted an average of five months. So even if ‘this time is different,’ it’s highly likely the market will recover quicker than you expect. As long as you have a carefully designed financial strategy in place that includes an ‘income ladder’ or “liquidity bucket’ to provide spendable cash at the right time and in the right amount, a market decline should have little effect on your financial life. A prudent investment strategy insulates you from market volatility, keeps you from being forced to sell when prices are down, and ultimately sustains you throughout every market cycle.
Changes in market prices don’t change your ownership share.
When you own stock in a company (hopefully many, many companies), you still own the same share of that company when the stock price changes. Remember, it is not the market itself that goes up and down; stock prices move up and down based on supply and demand. In the short run, the intrinsic value of a company doesn’t change when investor sentiments cause prices to rise and fall. The shares you own are your assets, and you continue to own those assets, regardless of the current price at which they last traded. Compare a share of stock to your house: if the price drops in half, you don’t own half a house.
Diversification is the prudent investor’s best friend.
There’s a simple reason prudent investors believe in the power of diversification: it works. Diversification reduces risk by spreading out risk across various investment vehicles (stocks, bonds, cash, real estate, etc.), industries, geographies, and more. Because these factors typically react differently to the same event, when prices rise in one area, they often drop in another. This balance helps maximize returns over the long term. As with most things in life, however, there is a potential downside: “diversification means always having to say you’re sorry.” When you diversify your portfolio, you are never 100% invested in the ‘best-performing’ asset class. Balanced exposure also means that there is always a losing investment in there somewhere, and only hindsight can tell you where you should have been invested. For example, in 2019 and 2020, large US companies have been the best performers, so why don’t we move our investments to capture that growth? Because that reactionary move is equivalent to ‘chasing returns’; metaphorically, we would be skating to where the puck used to be, rather than where it will be next.
Risk and reward require trade-offs.
When most investors think of risk, they think of risk as the chance that prices of stocks will go down. And that’s part of it—the possibility of speculative losses. Risk is a concept that drives capitalism in that you get paid to take risks. Let that sink in: you are paid to accept risk. Large dividend-paying companies give you two ways to get paid: growth in the stock price, and dividend payments. Avoiding risk by staying in cash means embracing purchasing power risk as your dollar depreciates from inflation. If you buy CDs for five years, you are trading on a hunch that interest rates will stay the same—and you will lose if rates rise. If you invest in stocks, on the other hand, you are offered a much higher potential for long-term growth. Over the last 20 years, the average returns for the three major benchmark indexes, the S&P 500, the DJIA, and the Russell 2000, are 5.9%, 7.03%, and 7.7%, respectively. Not bad considering that the financial crisis is part of that history. In short, a market downturn isn’t your most significant risk. Your greatest risk is you.
As I sit here at 4:00 in the afternoon on Wednesday, November 4th, still awaiting election results, I sit with you in uncertainty. Is the market going to crash? No one knows. But we do know that markets have crashed, gone through cycles, and come roaring back from defeat. And all that will happen again and again. The world is more complicated than a headline, a tweet, or even the most well written, well-researched article in the Wall Street Journal.
Last week, the media was full of predictions of who would win the election. But even with sophisticated algorithms and extensive polls, no one will know the outcome until all the votes are in and all the votes are counted. For investors, the best offense and best defense is an investment strategy that fits your time frame, is diversified, includes a wide margin of safety, and has time to do its job of delivering compound returns. So, I repeat, take a deep breath. If that doesn’t help, re-read what I wrote above. And if you find you’re still living in fear of what the market might do tomorrow, please reach out. As always, I am here to help.