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We’re human. And that means we’re vulnerable. Vulnerable to a vicious microbe 1-billionth of our size, as well as the one thing that makes us most human - our emotions.
As the novel coronavirus continues to exact its heavy toll on the world - in lives, in the cost of responding, and in lost production and consumption, it’s easy to succumb to the fear-driven thought “I’m going to move my investment portfolio into a money market fund and wait for things to settle down”.
This response is understandable. It’s the easiest, most comforting action you can take. But after you’ve made the shift and finally have a good night's sleep, you’ll wake up to a much more difficult decision - how, and when, to get back in.
You’re not Alone
As coronavirus fears wreaked havoc on stock markets around the globe, investors fled mutual funds and exchange-traded funds (ETF's) in record numbers for the safety of money markets. According to Morningstar, mutual funds and ETFs saw $326 billion of outflows in February, an astonishing reallocation that is more than 3X the previous record-breaking redemption of $104 billion (October 2008) during the heart of the global financial crisis. According to the Investment Company Institute’s Trends in Mutual Fund Investing – March 2020 report, investors have stuffed more than $4.3 trillion (yes, trillion) in money market funds, a tally 19 percent higher than the prior month and more than 40 percent higher than one year earlier.
When we feel afraid, we act. We are programmed to fix, mend, and meddle. And as productive as those instincts are to survival, investing is different. Emotions distort our ability to reason and push us toward the panicking herd which temporarily reduces our anxieties…but also our wealth.
If you’re considering selling your stocks, don't make that decision lightly. If you absolutely must get out, or have already done so, I encourage you to make it temporary. You’re paying a hefty price for the ‘safety’ of cash and your long-term success is more dependent on being positioned for the up than avoiding the last stages of the down.
Back to Work – Four Steps
Financial markets are efficient, human nature is not. Here’s a four-step plan for making stock market fluctuations work for you, instead of against you:
1. Boost your Savings
Keep some money in an emergency account. Any funds you anticipate needing within the next 12 months (24 months if you want to be even more conservative), should be tucked away in a savings account, money market fund or short-term CD’s. An appropriate amount of surplus cash separate from your investment portfolio can provide you the fortitude to survive a market downturn and avoid panic selling.
2. Plan with Purpose. (Or update the one you have.)
Develop, and adhere to, a well-thought-out financial plan and codify this plan in the form of an Investment Policy Statement or ‘mission statement’. Your plan should identify the right blend of stocks and bonds that will allow you to stay the course during difficult market moments and even rebalance into the pain. This kind of planning empowers us to move past uncontrollable variables, redirecting our attention to what really matters…the construction of an investment portfolio that has the tensile strength to withstand the test of time.
3. Look both Ways…and be Honest!
Pay attention to risk! If you’re the type to fret during times of stock market volatility, it won’t matter if your portfolio has the potential to double or triple because you won’t make it to the end of the rainbow - at least not with your sanity intact. The solution? An honest, objective appraisal of your tolerance for risk before the anxiety strikes. Tools like SAM (Smart About Money), a program supported by the National Endowment for Financial Education, or this quiz from Rutgers University can help.
4. Dollar Cost Average
Instead of jumping back in the market with both feet, draft a structured plan for putting your money back to work in a disciplined, systematic way over a pre-defined period-of-time. This tactic, often called dollar-cost averaging (DCA), eliminates the temptation of trying to time the market which serves to reduce stress and the risk of regret. DCA arms you with a framework to re-engage, as opposed to suffering wealth destruction from "paralysis by analysis". In essence, DCA advances the idea that it's better to invest slowly than to never invest at all.
Plan the Work. Work the Plan. (DCA the Right Way)
One of the central tenants of DCA investing is that the investor must overcome the natural behavioral tendency to avoid investing in down, declining, or volatile markets. When our well-reasoned DCA plan says something like “Today is step 3 of my 5 step DCA plan” and we discover that our disciplined self is at war with our inner fears, we must not succumb to thoughts such as I’ll wait for the market to fall 10% or, Let’s wait until we see the outcome of the upcoming election, or more ambiguously, l’m going to re-start my DCA plan after things settle down and I’m feeling more comfortable.
The lesson? Investing a large amount of cash is always going to make you nervous, and that’s ok. Although dollar-cost-averaging isn’t stress free (it actually turns one difficult decision into four or five), if it makes you more likely to reengage with the strategic parameters of your financial plan, then use it and follow through.
Kevin McVeigh, CFA is a Managing Director and Partner at Exchange Capital Management, a fee-only, fiduciary financial planning firm. The opinions expressed in this article are his own.
