When stock market uncertainty peaks, confidence in your financial plan is of critical importance — second guesses tend to be costly.
Take, for example, the Christmas Eve “meltdown” of 2018. Fears about trade and a Federal Reserve seemingly intent on hiking interest rates and risking a recession sent panicky investors to the exits and the market booked its ugliest Christmas Eve in history. Those who doubted themselves and jumped to the sidelines seeking safety in cash missed out on what ended up being a historic year for stocks.
Successful, long-term investing is a two-pronged challenge. The first task is mathematical: Invest in a diverse portfolio of assets (stocks, bonds, commodities, real estate and more) that fits your time horizon and risk tolerance. Financial advisors are experts at this step, and they can help build a portfolio and strategy that’s tailored to you.
But even the most well-constructed portfolio will experience the ups and downs of the market. And no one is an expert at timing exactly when the next downturn or subsequent bull run will begin. That’s where the second task comes in, and it’s all mental: Trust in the strategy and stay committed through good times and bad. Whether it’s a viral outbreak, a military strike or a bursting tech bubble, there are going to be times when markets are overcome with fear and doubt. But those who hold fast while the rest of the world panics, as we stated in our Q4 2018 quarterly commentary, tend to be rewarded for their resolve. And, much as we suspected, this recently held true once again (see below).
Unfortunately, many investors get rattled and abandon well thought out strategies when fear amplifies. The keys to building wealth are simple: Have an advisor. Have a plan. Stick to it.
STOCKS AREN’T FOR EVERYONE
It’s no secret that stocks are risky. Indeed, unpredictable swings in the value of stocks are just too much for some people to endure — not everyone can own them. And every day the market tests those who can own stocks and those who shouldn’t. Investors who sell their shares when the proverbial “stuff” hits the fan lock in losses for themselves and generate extra returns and opportunities for those who stick with the market. Data show that when fear spikes, those who stick to their guns tend to be rewarded.
The CBOE Volatility Index, known as the VIX, is a real-time market gauge that uses S&P 500 options to measure the market’s collective expectations for volatility in the coming 30 days. It’s also known as the “Fear Gauge”, and everyone from portfolio managers to television analysts use it as a barometer for fear and stress in markets. When the VIX is low, say a 12, markets are thought to be “calm.” On the flip side, a reading over 30 implies a jittery, fearful market. For context, the all-time median for the VIX is about 18, and the highest level ever reached was 89.5 on Oct. 24, 2008 at the peak of the financial crisis.
On Dec. 24, 2018, the VIX hit a reading of 36.07. Investors were incredibly fearful of two looming specters: The Federal Reserve appeared intent on hiking rates enough to risk a recession, and the U.S.-China trade war was intensifying. As a result, that day marked the largest Christmas Eve decline in history and a spike in the fear index.
Not only did we express our opinion in the Q4 2018 market commentary that both the Fed rate hike and U.S.-China trade war fears would dissipate before triggering a U.S. recession, but we also demonstrated that periods of panic are often the predecessor to extremely positive future equity market returns. Updating our study with the recently concluded period shows the market returned a whopping 39 percent from Dec. 24, 2018 to Dec. 24, 2019, which was not an anomaly.
A historical analysis of the VIX and stock returns looking back on the 7,285 trading days between Jan. 2, 1990 and Feb. 13, 2020 reveals that there have been only 258 days when the VIX was at or above 36.07 — extremely fearful. If you invested cash at the end of each one of these days and held for the next year you’d be doing quite well yourself. That’s because our study found you’d have generated a positive, one-year return in 246 out of 258 instances. In other words, 95 percent of the time the VIX hit 36.07, 12-month returns from that day go on to be positive, with a median and average return of 30 percent. Think about this as the cost of panic.
Now, we aren’t recommending some exotic investing scheme timed around the VIX. Rather, this study stands as striking proof that panicked investors create opportunities for investors who trust their plan through calm and stormy weather.
TO EVERY SEASON…
Even the most disciplined, sticky-handed investors need to decide how many more storms they want to endure. Stocks are a long-term investment. If you don’t need your money for 10 years or more staying invested has proven to be one of the best ways to grow your wealth over time. As your investment timeline shrinks, say, you’re just a few years from retirement, think about how the next market hurricane will impact your goals — and sleep cycle. Do you want to go through another dip like the one that occurred in 2018? It’s going to happen at some point in the future. If that prospect takes you too far out of your comfort zone, it may be time to ply toward calmer seas and readjust your asset allocation to something more suitable for your situation.
But don’t let the “Fear Gauge” force your hand. Meet with an advisor when times are good and adjust on your terms, not the market’s. After a strong 2019, it’s a great time to meet with your advisor to ensure your asset allocation is optimized and fits into your overall plan and risk tolerance. Uncertain times are undoubtedly ahead, but a quick annual review of your strategy will help you feel certain you’re on the right track.
While we’re often inclined to focus on how each investment did relative to a benchmark down to half a percentage point, just remember the more important point is this: Were you still invested? Without an advisor who provided an objective view from a distance, there’s a tendency to sell and miss out on a recovery. Don’t let a focus on 0.5 percentage points cloud the bigger, longer-term picture. Were you able to hold steady and capture that 39 percent gain from the Dec. 24, 2018 decline?
All investments carry some level of risk including the potential loss of principal invested. No investment strategy can guarantee a profit or protect against loss. Past performance is no guarantee of future performance.