Unique, but normal: riding out this market crisis

-- | 27/04/2020

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Scott Halver: In February of 2020, most global stock markets were trading at or near all-time highs.

Announcer: Another record day on Wall street, as the snazzy animation says.

Halver: Then,

Announcer: The number of cases of COVID-19 outside China has increased 13-fold.

Announcer: Every worker in a non-essential activity must stay home for the next two weeks.

Announcer: We will be denying entry to Canada to people who are not Canadian citizens.

Announcer: The coronavirus is continuing to spread in our country with alarming speed.

Announcer: Hundreds of thousands of people have left the labor force.

Announcer: The entire country with go under a complete lockdown.

Announcer: We will be extending our guidelines to April 30.

Halver: It's easy to think that this market crash only affects the wealthy, but across the developed world hundreds of millions of average citizens invest at least some portion of their savings in the stock market, and if they've looked at their statement recently, they'll see that they've also been hit hard. 

The circumstances of this market crash are unique to the coronavirus pandemic, but are such drops normal? Was anyone expecting this? What should an investor do now, and how can an investor prepare for the next crash? 

The global financial crisis and subsequent market crash that ended in 2009 has been described as a Black Swan, a unique negative event that could not be foreseen because no similar events had occurred in the past. However, if we look at historic data, we can see that there is a long history of market crashes. Financial researcher Larry Siegel came up with a more fitting term, Black Turkey, an event that is everywhere in the data-- it happens all the time--but to which one is willfully blind. 

Between 1871 and March 2020, we can see 17 Black Turkeys in the U.S., which would be market declines of 20 per cent or more. That means a Black Turkey happens about once every nine years. The pattern is similar in almost all developed markets. 

Now, this isn't to say that anyone could have or should have seen this market crash coming. And the good news is that markets have always recovered and gone on to new highs. The bad news is that no one knows how long it will take to get to those new highs.

Steve Wendel: It's perfectly natural. Right now, people feel unsettled. It's because of the reality of a global pandemic and the wild swings in the market that we've seen and also because of how our minds are wired. When the markets drop 10 per cent, we see an up and down, but when they go down 10 per cent, it's natural to think that they will continue to go down, and so we worry about that. We worry about what that means for our livelihood, what it means for our portfolios and our ability to retire comfortably.

Halver: This may make some investors want to sell out of stocks completely; however, most investors should not make drastic changes. If we look at a U.S. investor who sold out of stocks in 2009 and then reinvested one year later, we can see that they ended up with much less return compared to someone who stayed invested.

Christine Benz: If you encounter market volatility and you expect to need money within the next, say, two to five years, it's probably not too late to reduce your equity allocation. Yes, in a lot of ways, you're locking in losses, but the idea is that you're de-risking that money that you expect to spend soon. On the other hand, for funds that you won't need for a while, say, five or 10 years or even more, you probably want to leave those invested in stocks, let more of your portfolio heal, and grow for the future.

Halver: An investor's behavior in volatile markets often works against their long-term plans. What can an investor do to keep their behavior in check?

Wendel: First, we want to externalize our own rules, how we want to respond, and how we--what we value in investing. So write out your goals, write out your rules, "I trade under this price to fare value," etc. 

Second, take that and create a commitment around it. So, signing it matters. It makes a personal commitment, signing that statement. You can also make it a social commitment by giving it to your spouse, giving it to your advisor, and saying "These are the rules that I want to follow." 

And then third, we can use that and other techniques to add friction. So, setting a cool-down period before making any major changes--say, a three-day window after which it's OK to make a change but you have to wait those three days to think clearly about the changes you want to make.

Halver: Black Turkeys are unsettling, but they are an expected part of investing. If you focus on controlling your own behavior, matching your mix of investments to your time horizon, and maintaining a focus on the long term, you can weather this market crash and the next one, ultimately reaching your financial goals.

This report appeared on www.morningstar.com.au 2021 Morningstar Australasia Pty Limited

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