School’s in Session

Dennis Friedman

ALTHOUGH THE 2020 market plunge isn’t even six weeks old, there are already lessons we can learn from this financial crisis that can help us better manage our investment portfolio. Here are six takeaways from the current downturn, which has left the S&P 500 off 25% from its Feb. 19 high:

1. During a financial crisis, you often hear the phrase, “Stay the course.” It’s meant to encourage investors to stick with their financial plan during difficult times. This is crucial: You don’t want to panic and lock in your losses in a down market.

But it’s just as important to stay the course in good times. Investors who grew too exuberant during the last bull market—overweighting stocks and buying individual company shares rather than funds—are the ones who have likely suffered the most in this financial crisis.

Takeaway: Becoming complacent in a bull market can be as big a threat to our investment portfolio as panicking during a bear market.

2. Just as it takes a global effort to fight the coronavirus, it takes a globally diversified portfolio to survive a bear market. Since we don’t know which stocks and bonds will hold up best in a tumbling market, it’s prudent to own all of them.

Takeaway: The best way to execute this global strategy is with broad-based index funds.

3. Doing nothing is doing something. You hear your friends talk about buying more stocks during this financial crisis. Can’t make up your mind what to do?

If you do nothing, your allocation to stocks—as a percentage of your total portfolio—will shrink as share prices fall, hurting your portfolio’s recovery when the stock market turns around. On the other hand, even if you think you’re doing nothing, you may be buying because, say, you automatically reinvest your dividends or you own a target-date fund that rebalances for you.

Takeaway: Putting your investment portfolio on autopilot, so you automatically invest in stocks, is a good way to prevent irrational behavior and to stay on track during a bear market.

4. When you own an individual stock, you take on specific company risk. In effect, you’re doubling the potential danger: You’re not only taking on the risk that affects the overall stock market, but also shouldering the specific perils that can affect any one company’s shares.

Boeing is a prime example. The stock has suffered because of the overall stock market decline—but it’s also suffered because of the problems with its 737 Max airplane. The shares have been bludgeoned in this bear market, falling from above $340 in mid-February to below $100, before partially bouncing back, thanks to the stimulus legislation passed last week by Congress.

Takeaway: One way to reduce specific risk is through diversification. By owning a slew of different companies in different sectors, you reduce the risk that a few troubled companies will badly hurt your portfolio.

5. If you own stocks, it’s hard to escape a bear market’s wrath. For instance, you might imagine that companies that produce nondiscretionary items would be performing well right now. With the panic buying and long lines at the grocery stores, consumer staples should be a bright spot in this stock market.

Yet Vanguard Consumer Staples ETF, which tracks companies that sell consumer products considered nondiscretionary, is down 15.9% in 2020. Yes, that’s better than the 22.2% loss for Vanguard Total Stock Market ETF, but investors have still lost a heap of money.

Takeaway: A bear market spares very few stocks. If you want to limit your losses, your best bet is to reduce your stock market exposure—by holding more bonds and cash investments.

6. Risk is often hidden during the euphoria of a bull market. But in a bear market, our shortcomings are quickly exposed.

Takeaway: We should take this time to assess not only our portfolio, but also our own behavior. This could be a valuable learning experience—one that could help us improve both our investment portfolio and how we handle future financial crises.

Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. His previous articles include Be PreparedBearing Up and Time to Shrug. Follow Dennis on Twitter @DMFrie.

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Roboticus Aquarius
Roboticus Aquarius
2 years ago

Dennis, thanks for this very thoughtful contribution. A few comments:
2. I think it’s ok for a US investor to be all in US, but whatever one chooses, they should harken back to item 1 and be consistent about it.
3. Jack Bogle of Vanguard fame purportedly said, “Don’t just do something, stand there!”
5. Minimum Volatility funds are taking a hit too. They are down less than their indexes for the most part, but there’s no magic pixie dust to prevent losses in a recession. I would note, however, that among bonds, Treasuries tend to be a really timely diversifier.
6. Ugh. Sometimes it takes a while to realize how true this is. We’ve been working on our financial weak points, but it’s slow work. We could have used another 4 or 5 years to solidify things. Luckily we seem ok so far, but the problem with recessions is that you can lose your job and income at the same time that your assets are valued for less, and helocs and lines of credit get frozen. If we had to deal with all of that at once right now, we’d take some losses.

Roboticus Aquarius
Roboticus Aquarius
2 years ago

Great approach. 7 years is quite a challenge, we’re just hoping to be able to cover 2-3 before the next recession.

In fact, this has been really helpful. Thinking about this helped me realize I’ve been under-utilizing a perk from my employer involving after tax savings contributions that would help us do this faster in a way that’s accessible in a crisis.

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