Investing in stocks sure feels like a roller-coaster ride these days, but it’s one where you don’t know whether the next stretch of the ride will be up, down or level.
First came a dramatic meltdown in stocks starting in late February when major stock indices fell more than 30 per cent in little more than a month. That has been followed by a sharp rebound where stocks regained most of the lost ground in record time.
Now everyone wonders how the pandemic will play out, what the path to economic recovery will be, and how markets will respond from here, all of which is hugely uncertain.
That drama and uncertainty begs the question about what you should do with your investment portfolio now.
In many cases, the best answer is don’t do much. If you had set up your portfolio in a sound manner to begin with, then you should usually just stick with it. Certainly, you need to be prepared for a broad range of stock market possibilities. However, if the stock market roller-coaster ride is fraying your nerves, then now might be a good time to make some adjustments.
“If you were rattled by what happened — if you held on and then said, ‘I can’t go through that again’ — the markets have at least rebounded to the point where I don’t think you can feel awful about de-risking the portfolio,” says Dan Hallett, vice-president research at HighView Financial Group, an investment counsel firm.
At this point, you can generally reduce equity exposure without large losses. The widely followed U.S. S&P 500 stock index is within 10 per cent of its February peak and is up compared to one year earlier as of Friday, although Canadian stocks haven’t recovered quite as strongly.
“We’ve been given a gift here,” says Tom Bradley, president of Steadyhand Investment Funds Inc., an investment management firm. “If you absolutely can’t stomach what you saw in March, now is the time to reassess — maybe you should have less risk in your portfolio going forward.”
In any case, you need to set your long-term asset mix of stocks and relatively safe fixed income (like bonds and GICs) for the right reasons. It should reflect your financial objectives, risk tolerance, investing time horizon, potential need for withdrawals, and other factors. Since no one can reliably predict stock market trends over a short period like a year or two, you’re usually best off sticking with your long-term asset allocation through ups and downs in the market.
That means that when you encounter a sharp stock market sell-off — like in February-March — you should generally “stay the course” with stocks and avoid the temptation to sell at a steep loss. It is also a good idea to gradually rebalance, which means selling fixed income that has maintained its value and buying stocks at lowered prices to help you get back to your long-term asset allocation.
If the asset mix you have now is making you queasy, then it makes sense to change it when the time is right. But the hard lesson of the last few months is that if you want to reduce your exposure to stocks, try not to do it when stock prices are beaten down. Ideally try to wait for a time like now when stocks are at least doing OK.
But while that sounds sensible, the temptation to sell stocks in the panicky throes of a sharp downturn is hard to resist. You may rationalize that you will buy back into stocks when markets stabilize. But that often sets investors up for what Bradley calls “the hardest decision in investing,” which is buying back into the stock market after you’ve bailed. If you’ve been burned once, you’re liable to feel extra cautious about buying back stocks at the risk of being burned a second time. That’s left many investors who bailed out of stocks in the downturn missing the plane when stock prices took off.
The rebound happened with astounding rapidity. The U.S. S&P 500 rose almost 40 per cent in 50 trading days after the low in March, which is a record going back to 1932, according to James Mackintosh in the Wall Street Journal.
Now there are a mirror set of fundamentals to follow and behavioural mistakes to resist during the upswing. In place of panic-selling during the sell-off, there is speculative fervour to buy, driven in part by “fear of missing out” when you see other investors making big gains. It’s also easy for investors who had a little success jumping into the stock rebound early to be overconfident and think “they’ve got it all figured out,” says Hallett.
“Everything is faster,” he says. “The decline was faster. The rebound so far is faster. It lures people into these behavioural traps, both on the way down and the way up.”
Now “staying the course” on stocks should mean avoiding the temptation to load up. If you rebalanced early while stocks were lower and then rode stock prices higher, you might even have more stocks now than your long-term asset allocation tells you to have. In that case, you might need to rebalance the other way, by selling stocks and buying fixed income.
The ideal long-term asset mix between stocks and fixed income will vary by individual. The fixed income side of your portfolio should be largely or entirely in relatively safe investments like investment grade bonds and government-insured GICs.
While fixed income doesn’t yield much interest these days, you still need an ample amount for the stability it provides your portfolio. No one can reliably predict whether the stock market recovery will continue, level off, or suffer another steep downturn. A balanced portfolio will help prepare you to face each possibility in reasonable shape.
An asset mix of 60 per cent equities and 40 per cent fixed income is often used as a classic asset allocation for long-term investing, but you should vary that based on your stage of life and other individual factors. In my view, retirees with a moderate risk tolerance investing for the long-term should typically go for 50 per cent to 60 per cent equities, with the balance in reliable forms of fixed income. However there are many exceptions where more or less equity makes sense.
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Investors in the early or middle stages of their careers might set an equity allocation higher than 60 per cent — sometimes quite a bit higher — depending on risk tolerance and other individual factors. If you’re having trouble figuring out the right mix for you on your own, a good financial adviser can be a big help.
Now might also be a good time to build up a cash reserve in an investment savings account or money market fund if you haven’t already done so. That’s typically the first place to go to for cash to cover an emergency need. Many financial experts advise that you should have at least three to six months worth of spending covered by this cash reserve, although it is a good idea for many retirees to have more.
But in addition, the fixed-income part of your portfolio can do double-duty as a source of funds for sudden, unplanned needs that exceed your cash reserve. That can help cover you, for example, if you lose your job due to the COVID-19 crisis and stay unemployed for a prolonged period. The fixed-income part of your portfolio can be counted on to largely maintain its value, so it serves as a reliable source of backup funds if and when you need it.