The investment company T. Rowe Price recently prepared a publication for financial advisors to address their clients’ concerns about the current economic downturn and bear market. The publication focuses on thoughts that have been stated (and sometimes acted upon) by investors and historical investment data that advisors can use to calm investors’ fears. Below is a list of five frequently cited concerns and research-based information about historical investment returns and market performance:
The Market is Down-I Want Out- It is common for investors to want to seek relief from market uncertainty when stock prices are extremely volatile and/or heading south. Any other place to put their money seems “safe” by comparison, even Treasury bills or bank accounts paying 1% or less. The flip side of “going to cash” is that you lose the opportunity to buy shares of stock at reduced prices and/or to experience a rebound in the value of existing stock holdings (if you don’t sell them). Just missing a few of the market’s best trading days (which often come soon after big losses) can dramatically lower investment returns. The bottom line is to avoid “chasing” the markets and, instead, follow a long-term investment strategy based on your true risk tolerance.
I Just Retired and the Market Crashed-Now What?- The T. Rowe Price publication recommends forgoing annual inflation adjustments to retirement income withdrawals. In “normal” financial markets, financial advisors often recommend withdrawing no more than 4% of your retirement savings annually, with 3% annual inflation adjustments, to try to sustain your savings over 30 years. By making a slight adjustment (i.e., forgoing the inflation adjustment), the odds of not running out of cash can exceed 90%. However, investors who move their money to 100% bonds will have only a 5% probability of success of having their money last three decades.
Things Keep Getting Worse With the Recession- I Don’t Know How Much Longer I Can Own Stock- Again, it is very tempting to cash out during a prolonged bear market. History has shown, however, that markets rebound eventually and that market drops after crisis events have usually been followed by good rallies. For example, one month after 9/11, the Dow Jones Industrial Average (stock market index) was up by 8%. After six months, it had risen 21.2%. In addition, cash assets generally do not have enough “earning power” to regain losses incurred by selling stock at a loss. The T. Rowe Price publication notes that the stock market has generally been resilient in the face of crises and that cashing out doesn’t pay. In addition, history has shown that the stock market looks forward and has tended to recover well before the economy recovers from a recession.
The Market is So Crazy Now-What Can I Do?- One thing that investors should do, in both bear and bull markets, is to rebalance their portfolio. This means periodically bringing the percentage of their portfolio in each asset class back to their original plan (e.g., 40% stocks, 40% bonds, and 20% cash) as weightings shift according to market conditions. In a bear market, rebalancing could involve buying more stock at a time when it is “on sale.” Rebalancing is a systematic way of buying investments when they are at a relatively low price and, over the long term, can help investors smooth out the effects of a volatile stock market. Some investment companies and retirement savings plans will rebalance your portfolio annually, upon request, typically on a specific date such as your birthday.
I Just Got My Statement and I Can’t Believe How Much Money I Lost! I Want Something Safe- As noted above, cash investments can’t sustain a retirement income stream for very long. T. Rowe Price notes that $500,000 invested in an all cash portfolio (measured by the performance of Treasury Bills) in 1978 would have lasted only 14 years. Only a portfolio comprised of more than half in stock was able to last over two decades. Even if you’re not retired, everyone needs to be concerned about inflation, which is a “silent” investment risk compared to much more widely publicized stock market volatility. Only stocks (over the long term) can help overcome it. For example, if inflation averages 3% or 4% over the next 20 years, $1,000 will be worth only $554 and $456, respectively.
