Can You Deal With A Stock Market Downturn?
Sometimes we’re late to interesting polls, but hey, they’re still interesting. Back in November, Gallup and Wells Fargo polled people to ask them how well they could stomach a “significant” market downturn, publishing the results on January 22nd . Or note, they defined significant as 5-10%. The results were quite confident: Gallup/Wells Fargo Downturn Poll Some wacky lines there – 87% of stockholders were at least moderately confident in their portfolios, and 82% of investors overall. People in a better position to actually handle downturns with smaller returns – those who don’t hold stocks – were only 61% moderately or better confident. Should We Trust Our Peers at their Word? In a word, no. These are interesting results, for sure, but I see lots of problems here – not just the fact that a significant downturn is defined as only 5-10%. The most recent recession saw drops an order of magnitude larger – in percentage terms (!) – of over 50% in major indices. We lost major financial institutions over a hundred years old, investors panicked, and maybe 10% of people (that’s a stretch) were confidently buying at any opportune time, let alone not panic-selling everything they owned. (We played around with what a “significant” drop might actually be in the past, but found you can be more than a few years early with your calls in some circumstances and still weather a downturn.) So let’s concentrate on our peers’ answers themselves. Do you really think this poll accurately reflects how people would react in a downturn? No, neither do I. You’ve got something of a Lake Wobegon effect going on here – you know, the “fictional” town where everyone was above average. In reality, stock markets have a tendency to over-correct – markets historically oscillate somewhere between ridiculously overpriced and a bargain (of course, identifying those periods is, perhaps, impossibly hard except in retrospect). That’s because previously confident people are selling into a downturn – “locking in losses” – and buying only when the stock market has come back “buying the highs!”. In fact, identifying actual investor results backs up those statements to a degree you’d almost think impossible. Dalbar releases studies on actual investor performance in the markets versus price (or dividend reinvested price) returns, and the results are crazily disconnected: through November 2015, in the order of earning 5.5% on S&P 500 funds in the last 20 years, versus stated returns around 9.85% . (We have a calculator so you can see dividend reinvested returns for the S&P 500 and the Dow Jones Industrial Average). Okay Smart Guy, What Then? For the average investor – and, Wobegon aside, we’re all probably closer to average than we tell ourselves – the best move is to set it and forget it. Consistently, when we do have market downturns, it turns out that many investors have actually overestimated their intestinal fortitude. For a typical person, the best move is to set your portfolio during market doldrums , with a mind to setting in up in such a way that you won’t mind too much if there is a massive move to either the upside or downside. As for re-balancing, it’s best if you go in with a plan, and openly rebalance at a standard time – and, if you can, avoid doing it that often. Believing in your portfolio is one thing, but investing during mania or a crash is no formula for a successful long-time plan. So, make the case. Would you be prepared for a significant downturn without selling most of your portfolio? Why, or why not?