Knowing what you know now, what would you have done differently leading up to the arrival of COVID and in the months and years that followed? It’s a question a lot of us have asked about everything from whether we should have traveled more in 2019 to whether we really needed that new treadmill when the old one had sat unused for years. These kinds of what-if questions can be a healthy mental exercise in all aspects of life, including financial planning and investing.
No two investors reacted to the pandemic and market distortions of the past three years in the same way. Experienced investors as well as those who simply dabble in the markets charted their own courses and acted as they thought best given what they knew at the time. Some pulled their money out of the markets after the first big sell-off to sit on the sidelines, while others stayed the course, trusting that the markets and economy would eventually bounce back. Of course, the risk tolerance and performance needs of investors can vary significantly, and, therefore, specific decisions will, too; but thanks to the benefit of time, we can now look back with a clearer view of how things unfolded and see what broad lessons can be applied in the future. Here are some of our key takeaways:
Time in the market can beat trying to time the market
The speed and intensity of COVID’s arrival was considerable. In late 2019 to early 2020, little was known about the virus and how quickly it could spread. While there was a general sense of concern around the potential seriousness of the outbreak, few could have accurately forecast that the global economy would come to a grinding halt just three months after the first known cases were identified globally and two months following its arrival in the United States.
The market’s reaction to the pandemic was severe. After hitting a new all-time high on Feb. 19, 2020, the S&P 500 plummeted nearly 34 percent in just more than a month, reaching the pandemic bottom on March 23. The speed of the sell-off was unprecedented, with the early 2020 period marking the shortest time frame from peak to bear territory in more than 90 years. While the markets bounced back from their lows with the S&P 500 finishing the quarter down roughly 20 percent, for some the rebound was too little, too late—as many investors had already headed for the exits. The move of many to the sidelines in hopes of waiting until the worst of the pandemic had passed proved costly. Just as the downturn was severe and sudden, the bounce back was nearly as ferocious. Unfortunately for those who sold out in hopes of waiting for the pandemic to subside, the S&P had already registered a new high by the middle of August, even while COVID case numbers remained high. In fact, if an investor had the misfortune of jumping into the market on February 19, 2020, which was the start of the COVID plunge, the annualized return through May 11, 2023, the day that the COVID public health emergency declaration in the U.S. ended, would still have been 6.36 percent annualized (or up 8.07 percent with dividend reinvestment).
Investing During Uncertainty
A common refrain we often hear during times of uncertainty is this: Why shouldn’t investors just go to cash and wait it out? We answer that in two ways. First, we recognize there are degrees of certainty (think confidence), but there is no point in time in which investors can be absolutely certain of an outcome. As such, if you invested only during periods of absolute certainty, you would risk missing out on substantial returns. Second, concentrating in one asset class suggests investors are absolutely certain of what is coming next for the economy and markets.
There can be a cost of missing out. In fact, missing just the 10 best days for the S&P 500 over the last 20 years would have caused an investor’s portfolio to return almost 50 percent less than staying fully invested. Put another way: If you invested $100,000 20 years ago, it would be worth $627,548 as of the end of last year. If you missed those 10 best days, you would have $287,503. There will always be a seemingly compelling reason to sell out of the market or to try to time your entry point back into stocks, but history has shown that investors who have stayed invested have been rewarded.
Tying this together is the reality that we are now three years past what could be classified as one of the most uncertain time periods in recent history. Markets took a harrowing ride in the first quarter of 2020, when stocks fell 34 percent in a mere 23 trading days in response to the arrival of COVID-19. Consider the missed returns of an investor who exited the market at that time (because of uncertainty) in the subsequent months. Additionally, imagine the challenge investors would have faced in trying to find the right time to re-enter the market after having gone to cash. Would they have waited for a more certain time to do so—perhaps toward the beginning of 2022 after the market had risen to new highs? But if they jumped back in at the new high, they would have experienced the more than 25 percent drop as we moved back toward uncertain times. We would suggest investors concerned about the current uncertainty consider that the S&P 500 is higher today than it was prior to the start of the pandemic, despite a global lockdown and two bear markets.
Key takeaway: Investors who try to time the market run the risk of missing periods of exceptional returns, leading to significant adverse effects on the ending value of a portfolio. As our research shows, staying the course can help investors avoid missing out on long-term gains. It’s important to remember that when it comes to investing, consistency wins the race.
When the markets are down, deviating from a long-term investment strategy can increase the odds of missing the best days. Missing those strong days can have a significant effect on your long-term investment performance.
Small changes can make a big impact
Given the length of the bull run leading up to the arrival of COVID as well as the historically low inflation that persisted for years leading up to the pandemic, some investors had grown complacent by the time the virus first appeared. As a result, many portfolios were left to drift away from well-diversified asset allocation plans and were unprepared for the challenges COVID brought. For example, in the years leading up to the pandemic, some investors had concluded that inflation was a thing of the past and a risk that no longer needed to be accounted for in an investment plan.
We viewed talk of inflation’s demise as misguided, and our portfolios contained an allocation to commodities as a hedge against rising prices. When COVID first struck, we anticipated that government leaders would flood the economy with liquidity to counteract the damage done by the shutdown initiated at the beginning of the pandemic. With that in mind, we took a two-pronged approach; we increased our exposure to equities at this time in the belief that the flood of liquidity would cause a surge in the economy, and we added gold as an inflation and uncertainty hedge; we also added some exposure to Treasury Inflation-Protected Securities (TIPS) based on our belief that the excess liquidity coupled with supply chain disruptions would lead to a surge in inflation.
Now we are on the opposite side of the cycle. Investment-grade bonds, which were yielding just 1.02 percent at their lows in 2020 when we made our allocation shifts, are now yielding 4.8 percent, and we believe inflation is set to retreat further. As a result, we have reallocated some assets back into bonds and eliminated our overweight to equities.
Key takeaway: Instead of making wholesale changes to an investment portfolio based on predictions of an unknowable future, we believe a comprehensive financial plan created with your financial advisor will be designed to account for those unforeseen bumps that inevitably happen along the way. Small tactical tweaks to a well-diversified investment framework can reap rewards without creating undue risks by putting all your investment eggs in one basket. It’s OK to adjust based on your informed outlook, but those tweaks should be done in an effort to get you to your goal perhaps more quickly and with a little less volatility. However, we believe adjustments should be modest in size and are never a substitute for a well-diversified investment plan.
Risks can be unpredictable, diversification can help
The economic and social disruptions from COVID were unprecedented in our lifetimes. The financial reverberations caused by the pandemic and measures enacted in response continue to be felt today and have made for asset class performance that strays from its typical behavior. For example, Large Cap equities, as represented by the S&P 500, have been viewed by many as the asset class of choice due to the perceived safety that comes with the size of the companies in the index and its relatively strong performance during the past five years. But after finishing 2021 as the second leading performer among the major asset classes we follow, the group finished 2022 near the bottom—with only REITS and Emerging Market equities faring worse. A closer look at the underlying performance of U.S. Large Cap stocks highlighted a renewed sensitivity to prices paid for companies. S&P 500 value stocks outperformed S&P 500 growth stocks for the first time since 2016 (and by the largest amount since 1999), with value down 5 percent compared to a loss of nearly 30 percent for growth companies.
Similarly, bonds, which had long been a hedge against negative returns for equities, struggled in 2022 as the Fed raised rates and yields jumped (bond prices and yields move in opposite directions). Unfortunately, poor performance for fixed income coincided with negative returns for equities. As you can see in the chart below, calendar years in which both fixed income and equities post negative returns are rare. Since 1926 there have been only five times in which both major asset classes posted negative returns for the same full calendar year. During four of those five periods (1931 being the exception), commodities posted positive returns with an average gain of 54 percent. Put differently, when fixed income didn’t provide the benefits of diversification, commodities did.
Balanced Portfolio Challenges
Key takeaway: Emotions tend to steer investors down the path to what seems the safest option with the least painful experience. This mindset was front and center for many during the tumultuous weeks and months following the arrival of COVID.
We know it’s not easy to watch the value of your investments fall. While it’s impossible to predict exactly when the markets will rise and fall, we know it will happen—and we plan for it. A financial plan is designed to help you weather swings in the market like we’re seeing today by 1) helping you understand the purpose of your assets in your plan and 2) suggesting the right types of assets, such as stocks and bonds.
A smart investment strategy leads with a steady outlook and looks through an objective lens that incorporates valuations and considers where we are in the economic cycle, the forward path of monetary and fiscal policy, and market structure. Additionally, the best financial plans include a focus on risk. That’s because true wealth is often gained during bad times, not just good ones. Those who sell stocks during a downturn lock in losses.
When developing an asset mix, a robust planning process examines the risks of volatility to your plan using Monte Carlo simulation, which examines hundreds of possible paths for the markets. In other words, the reality of bad news is already built into the plan; so when turbulence arrives, it shouldn’t derail you from reaching your financial goals.
The opinions expressed are those of Northwestern Mutual Wealth Management Company as of the date stated on this material and are subject to change. There is no guarantee that any forecasts made will come to pass. This material does not constitute individual investor advice and is not intended as an endorsement of any specific investment or security. Information and opinions are derived from proprietary and non-proprietary sources.
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