Stick With Your Plan
Over the weekend I had a discussion with some friends on Facebook about the Dow’s sharp sell-off over the past few sessions. Some people were panicking, and some were asking “What’s the big deal?”
One friend put it all in perspective when he wrote: “I simply do as I’ve always done… stay the course.”
That’s an important perspective that I will address in more detail below. But let’s first discuss what’s going on in the market.
A Broad-Based Selloff
The sharp sell-off that began last Friday has been extraordinarily broad-based. Google Finance shows the last 20 quotes I accessed, which covers most of my portfolio and several companies I track. Of the 20, only the CBOE Volatility Index (INDEXCBOE: VIX) was up (+28.51%) on Friday. The other 19 quotes, which span just about every sector, were all in the red.
Some of my friends shrugged off the drop. After all, investors have experienced one of the longest bull markets in history, and the occasional drop should be expected. Over the past five years, there have been a couple of 10% corrections, but both were short-lived. Yet such a long period of low volatility is unusual.
So is this a brief correction, or the start of something like 2008, when the major indices fell by 40%?
Fear Creeping Into the Market
Analysts have offered several explanations for why the market dropped. One is simply that overextended markets undergo corrections. Wage growth is stoking fears about interest rates, as my colleague, John Persinos explains. As John points out, the VIX measures fear in the stock market, and that fear is rising.
But why is fear rising? Let me add one more perspective to the mix.
First, oil prices have risen sharply in recent months. Rising oil prices often precede market corrections.
Second, we are in the midst of a political crisis underway that could be headed toward a constitutional crisis. During the Watergate crisis in the early 1970s, the entire world experienced one of the worst bear markets in history.
Of course, in addition to the political crisis, there was an oil crisis going on as the Watergate scandal unfolded. The net impact was that from 1973 to the end of 1974 the Dow Jones Industrial Average lost over 45% of its value.
Stay the Course
We don’t know what’s going to happen next, but my friend had it right. You have to stay the course. Your course, which may not align with someone’s else’s course.
If you have a long time horizon, don’t fret too much about market volatility. In 2008, I watched my portfolio get nearly cut in half. But I had a long time horizon, and I felt like my investments were good long-term picks. My portfolio recovered, and then it soared during the bull market. This year the investments I held during the financial crisis reached four times the value they had during the financial crisis.
But if my time horizon had been shorter, my plan would have been different. You need time to recover from a 50% loss, and as you move toward retirement, your time horizon declines. You need to shift from riskier stocks to lower risk investments.
If you need the income during retirement, you need to shift into income-generating assets. Choices may include:
- Real estate investment trusts (REITs), which my colleague Scott Chan recently discussed
- Master limited partnerships (MLPs)
- High-quality bonds
- Blue chip stocks
- Conservative mutual funds
But the critical thing to remember is that it’s YOUR plan. You must execute it based on your circumstances, and all financial advice you receive should take that into consideration. Those circumstances will be primarily dictated by your time horizon and risk tolerance. Don’t risk money you won’t have time to recover.
Investors don’t like uncertainty, especially late in a bull market. When people start losing faith in institutions, investors get nervous, and you start to see a lot of volatility.
So, should you worry about last week’s sell-off? It depends. If your portfolio is weighted heavily toward growth stocks, but your time horizon is starting to get short, then yes. This sell-off should serve as a reminder that 30-40% corrections do happen, and unless you have time to recover from such a correction, you should probably start to ratchet down the risk in your portfolio.
Even if your time horizon is a bit longer, this is probably a good time to reassess your goals and adjust your portfolio as needed.