As stocks have a bit of a meltdown today, there have been frenzied calls about what to do and what will happen next. Here are some thoughts on what to do when the sky is falling.
Will the markets go up? Will they go down?
Short answer: Yes.
What should you do? Not panic.
What to Do When the Sky is Falling
This is not the first time that the market has given us pause. And it won’t be the last.
For some perspective, consider the doom and gloom when the US Government had a shut down. During that crisis in October 2013, I posted “Debt Ceiling Crisis: What Investors Should Do” with some practical tips that still hold true today.
During the “Black Thursday” plunge of August 2011, I wrote in a post titled “Buckle Up and Hold On: Investment Roller Coaster Ahead,” that folks should hold on, hedge, and rebalance.
These are far from the only or most recent times that this has happened to us. Remember the Brexit vote? The Greek Debt Crisis? Trade war by tweet?
Control what you can
Now’s as good a time as any to be sure you have an investment mix that meshes with your risk tolerance and Risk Number. And if you don’t have a cash cushion, then that should be the priority but that doesn’t mean selling everything and placing it into cash.
Now’s a good time to rebalance. There will be lots of stuff on sale. And who doesn’t like a good sale? With the downturn, there will be a chance now to buy stuff that may have looked pricey before today.
Look at your investment expenses
While there are lots of moving parts when it comes to investing that you don’t personally control, here’s something that you can control directly. Look at your holdings and try to weed out the more expensive options and replace with lower cost choices.
But remember that price is only ever an issue when all else is equal. Comparing two broad passively managed index funds? Then comparing based on the expense ratio makes sense. But in other cases, you may have an actively managed fund that helps lower the risk profile of your portfolio or boosts your income because of how it invests in yield-producing investments. In this case, you may find these holdings to have a higher total “cost” but they may still be worth it when looking at other factors (i.e. risk, performance, downside capture).
Hedge Your Bets
The best way to hedge your bets is to diversify. Instead of having all your eggs in one basket, you have your money spread out. But how? This goes back to knowing your Risk Number and aligning your portfolio allocation to it. For DIY investors, consider holding a stock allocation equal to 110 minus your age.
This works because when one type of stock goes down it may be offset by another stock. Likewise, when stocks are going down, other investment types – like bonds – will move differently.
But strategic asset allocation isn’t the only tool to hedge portfolio risk. Another way to hedge risk is to use financial options – like calls or puts – that can basically put a floor under the price of the stocks held. While an investor can directly place an order for such financial derivatives, there are a number of mutual funds or Exchange Traded Funds that do it for you.
These include Neuberger Berman US Eq Idx PtWrtStrt A ( NUPAX) or Invesco S&P 500 BuyWrite ETF (PBP) or, my favorite, a combination of Global X NASDAQ 100 Covered Call ETF (QYLD) and Eaton Vance Tax-Managed Buy-Write Opportunities ETF (ETV). All of these produce an income stream for an investor and provide a hedge designed to zig when the underlying index may be zagging.
Cash is Not Trash
While cash can be a drag on a portfolio since the rate of interest is typically very low compared to the potential return on stocks, it is still a great cushion for a portfolio. For my retiree clients, they are rightfully concerned that a market downturn hurts. They don’t have a lot of runway or time to make up for market corrections.
This is why I advise that they hold cash in an amount equal to at least six months (and preferably at least one year) of living expenses. To lessen the “opportunity cost” of holding cash, I recommend using one of the higher-yielding money market options found at www.BankRate.com . Another good option is to hold cash in an ultra-short-term bond fund like Vanguard Short-Term Bond Fund ETF (BSV).
Tactical May Be Practical
When it comes to investing, there are those who stand in the “buy and hold” camp and others who follow a more active approach. Tactical investing describes a range of approaches but what they generally have in common is “doing something” based on certain signals. Sometimes these signals are based on trading patterns or the momentum of trading volume in a stock, sector, or index.
For individual investors – and many investment advisers – trying to time the market can be difficult at best. Executing a trading strategy takes time and most busy people just don’t have the time, tools, or inclination. And by the time a trade is executed in response to the “crisis du jour”, the market has recovered.
While not a core of what I do for clients, I will subscribe to third-party models or actively-traded mutual funds that use such techniques. This adds a different level of diversification to a client’s investment plan.
Investment forecasting is like crystal ball gazing or reading tea leaves. On any given day there is something that can bring out the doom and gloom in otherwise cheerful people. Last month it was an impeachment trial. Today it is a spreading virus.
So what is the forecast? Well, cloudy with chance of good news or variable risk of Armageddon. Trying to read the tea leaves and make prudent investment decisions for clients – or yourself – has been complicated today by the headwinds starting in China. The best thing that anyone can do is not panic but use this time to reassess and rebalance.
While it’s tempting to give in to the emotional “flight” survival response that you’re feeling right now, don’t give in. Stand and fight instead. But fight smart. Have a plan and consider a professional navigator.
For additional context on this, feel free to explore this article in Financial Advisor magazine: Euphoric Year for Stocks Falls Apart with Outbreak Pummeling S&P.