Investment Discipline that is Easy in a Booming Market Can be Really Tough in Times Like These
So today was a doozy. Stocks fell by 10% in the biggest one day loss since Black Friday of 1987 (or was it Black Tuesday?). But in my almost daily posts, I’ve been through all this already, so how about a little gallows humor to lighten the mood?
Q. What happens to Tom Hanks if he gets bit by a tick?
A. He gets Corona with Lyme.
Ok, now on to more serious topics.
When the market is going up, year after year, investing looks easy. Take a basic portfolio management exercise called rebalancing which is recommended by almost every investment expert. In a good market it works like this.
Suppose you decide (perhaps with the input of a wise financial advisor) that your ideal portfolio is 50% stocks and 50% bonds. You have a $200,000 portfolio, so you have $100,000 in stocks, and $100,000 in bonds. Then lets say stocks go up by 20%, while bonds (due to rising rates perhaps) went down by 10%. You now have $140,000 in stocks and $90,000 in bonds. Just from the stocks going up, you now have a portfolio that is 60% stocks and 40% bonds. So the experts say you should sell some stocks and buy some bonds, so that your portfolio is back to your target allocation.
This is a very easy, stress free operation. After all, it doesn’t feel bad to book gains after a mighty runup. Of course, some investors will be tempted by greed to “let it ride” and thus let their risk gradually creep up – but the actual rebalancing exercise is easy.
But when markets tank, the exercise becomes extremely difficult and takes discipline and courage. And one needs look no further back than this afternoon to understand why.
From the market peak a few weeks ago, the market indexes are down almost 30%. Taking the above example, the $100,000 in stocks is now $70,000, while maybe the bond portion might have grown to $105,000, for a mix of 40% stocks and 60% bonds. Good investment discipline says you need to buy some stocks and sell some bonds to bring your portfolio back in line with your long term strategy.
But wait? Buy stocks? But they are down 30%? Are you insane? The cononavirus is rampant, it will surely tip the economy into recession, surely this isn’t a good time to buy more stocks, is it? Everyone I know is selling! And government bonds are the only thing that hasn’t gone down this month. Sell them? It just doesn't feel right. Its sort of like scheduling a colonoscopy – your brain tells you you need to do it, but….its really hard to do.
But it is no tougher today than it was in 2008, when the entire financial system was on the verge of collapse and CNBC pundits were predicting 1929 like economic disaster. Or in 2000, as high flying stocks were suddenly deemed worthless, or 1987 following the one day greatest loss ever of 25%. But in each case, buying stocks cheap as markets fell to new lows (which is what rebalancing forces you to do) paid off big for investors after markets eventually recovered. In fact you MUST rebalance at some point during a market rout – because if you don’t you will be way under allocated to stocks when the recovery does come – making it difficult to recover your losses. Making it just a little easier is the knowledge that there has never been a better time to buy stocks than in the midst of the most intense market selloffs in history. The carnage and fear during those times is where opportunity is inevitably hiding.
My investment philosophy, developed in the school of hard knocks, is that it is impossible to predict ahead of time what the market is going to do. Trying to get in and out of stocks to avoid the pain of a downturn and getting back in before the market goes back up is a fools errand. No one can do it effectively (although there is such as thing as dumb luck). Maintaining a good sound asset allocation through a disciplined rebalancing practice DOES work, and has worked effectively in crisis after crisis. I am confident that this crisis will ultimately be no different.
(past performance is of course no guarantee of future results!)