The gut-wrenching volatility of current markets brings out ‘loss aversion’, a well-known behavioral bias. Most people actually prefer avoiding losses to making equivalent gains: they’d rather not lose $20 than win $20. Scary environments activate the reptilian part of our brain, creating a counterproductive fight or flight response. While we all know equity investments are the growth engine of portfolios, it’s hard to keep buying them during a period of dramatic market uncertainty. In fact, some people choose to sell instead.
But such an approach can lead to missing the big up days, with very real long-term consequences...
Growth of $10,000 invested Jan. 1, 1980
After a significant equity sell-off, history demonstrates some outsized future equity returns, and those rebounds can happen very quickly.
Traditionally, bonds are used as a hedge for equity investments. In the past, bond prices often went up when equity prices went down. This time, as 10-year Treasury rates approached zero, the bond market showed us that never-never land doesn’t exist. While longer term Treasury bonds provided temporary protection, even they have fallen in price this week. Investment grade bond funds (which include bonds issued by highly rated corporations) have gone down even more in value due to credit concerns.
It’s notable that short-term U.S. treasury rates (commonly referred to as the risk-free rate) are .02%, and the days of risk-free returns appear to be over for now.
What to do?
- Have enough cash to live on for one to two years.
- If you need more cash than you have available:
- Check whether you are automatically reinvesting your interest and dividends. You can change your election in order to get cash distributions instead.
- Rebalance – sell assets that have held their value, such as short-term bonds and avoid being underinvested in equities relative to your financial plan.
- If you don’t need to withdraw from your portfolio – rebalance incrementally. By definition, you will be buying equities at lower prices in the current selloff.
- Consider adding gold – gold traded down this week as investors sold any securities that still had a gain. Gold doesn’t provide any cash flow, but if real interest rates are 0% or negative, investors won’t be giving up much income when they consider their alternative investments. And… what if the current deflationary scare eventually gives way to inflation as a result of our debt levels, the Fed adding trillions of dollars to the monetary system, and Congress providing over a trillion dollars in assistance to individuals and businesses?
1) The hypothetical example assumes an investment that tracks the returns of the S&P 500® Index and includes dividend reinvestment but does not reflect the impact of taxes, which would lower these figures. There is volatility in the market, and a sale at any point in time could result in a gain or loss. Your own investing experience will differ, including the possibility of loss. You cannot invest directly in an index. The S&P 500® Index, a market capitalization–weighted index of common stocks, is a registered trademark of The McGraw-Hill Companies, Inc., and has been licensed for use by Fidelity Distributors Corporation.
2): US stock market returns represented by total return of S&P 500® Index. It is not possible to invest in an index. First 3 dates determined by best 5-year market return subsequent to the month shown.
Nothing contained herein is intended to be a formal research report, or as a source of any specific investment recommendations and makes no implied or express recommendations concerning the manner in which any accounts should be handled. Any opinions expressed in this material are only current opinions and while the information contained is believed to be reliable there is no representation that it is accurate or complete and it should not be relied upon as such. Investing involves risk, including loss of principal, and no assurance can be given that a specific investment objective will be achieved.
2x Wealth Group is a team at Ingalls & Snyder, LLC.,1325 Avenue of the Americas, New York, NY 10019-6066. (212) 269-7757