You should likely build a low-cost, well diversified portfolio and stick to it through any turbulent market. But, this is a great time to evaluate if your portfolio is ready for a crash if you’re about to pay for retirement or college. And while the U.S. market has seen amazing growth over the past decade pushing it to higher valuations, that is not true overseas. Now is a great time to check whether you’re truly diversified or you’re putting all of your investing eggs in one country.
I am a huge Kansas State football fan. What I worry you might have just read was “He lives in Texas, so he likes football.” What I meant was, I could tell you how KState scored on the University of Ohio right before halftime in 1997…or how special teams cost us a national title in 2002 and Texas somehow beat us in Manhattan (nevermind 1998 or 2012).
I bring this up because college football is the source of my greatest contrarian prediction of all time. Growing up in Kansas City, I went to every home game and a few away games each year with my dad and brother. I have seen several Heisman trophy winners, future Pro Bowlers, and national title teams over the years. But several years ago, I was certain that I had spotted the greatest quarterback I had ever seen.
Here’s the thing, though. Almost everyone disagreed with me. His freshman year, his college coach ran off the backup quarterback, causing him to transfer. The quarterback he ran off went on to win the Heisman trophy. Throughout their college years, everyone talked about how crazy that coach was to pick against a future Heisman winner. I backed this particular coach and said he made the right call–he kept the best quarterback. Even while watching the other quarterback with the Heisman trophy, I doubled down–he wasn’t as good as this quarterback. This quarterback put up big numbers, but he played at a school where that was common. They threw a lot every game and had produced a prolific Q.B. for decades, so most dismissed his work. But I was insistent. This was different. This quarterback was not like the rest.
Fast forward to the NFL draft. Most analysts thought it was crazy for a team to draft my quarterback as high as they did. He sat for his entire rookie season while other rookies in his class thrived. Still, I held to my guns. I had never seen a quarterback like this one. He was not a “system Q.B.” in college; he was the greatest quarterback I had ever seen.
The quarterback I’m referring to is Patrick Mahomes.
I will likely never have a better sports opinion ever. We’re only a couple of years in, and it’s already a landslide. There has never been a quarterback as talented as Pat. At the end of the day, it’s fun to be right, I’m glad he’s a Chief, but my prediction was lucky.
Let’s get to the point. We’re in the middle of one of the worst weeks in recent market history. But that’s the thing–it’s just a week. It’s not a big deal; the market has simply pulled back to prices we saw late last year.
The question is, where does it go from here?
My prediction is that the market will go drastically higher. I don’t know when, and I don’t know how. I don’t know if the ascent will start tomorrow, or if the market will fall further from here before recovering. I don’t know which companies or sectors will propel the growth, but I’m confident it will happen.
I believe in equities.
The stock market is not a nebulous web of uncertainty. It’s not a casino. It’s an ownership stake in real companies. The largest, most well-funded companies that exist on the earth. Companies that are going to wake up tomorrow and serve their market at a high level. Likely at the exact same level even if the market tanks. This is a common but important idea. Amazon or Coca-Cola or McDonalds are good companies providing value to the markets they serve. This is true regardless of what happened to their stock price last week.
You are going to hear a lot of warnings from a lot of different people. The warnings will talk about how markets are bound to come crashing down after such a long bull market. The warnings will call for drastic action like avoiding the stock market entirely.
In some ways the warnings are not entirely wrong, and I will discuss the action you should take–especially if you are within 5-10 years of needing your portfolio for income. In most other ways, the warnings are very wrong and following them will likely cause a big mistake.
Let’s start with the latter. If you are planning to make a substantial change to your portfolio because of the Coronavirus, you should likely pause. Why?
Let’s understand your options
You could ensure you have a well diversified, low-cost portfolio tailored to serve your individual goals and desires and wait it out.
You could jump out of the market and wait for Corona to pass before hopping back in.
Let’s understand the magnitude of getting out of the market
If you follow financial advice on social media, you may have noticed that my first bullet point above (stick to a well-diversified portfolio for the long haul) has become the basic talking point of almost every financial advisor. Sometimes it is met with animosity–after all, if all your financial advisor does is parrot the same talking points during every volatile market event, what in the world are you paying your advisor for? As I have said loudly since starting Brownlee Wealth Management, there is some truth to this. If you’re paying 1%-1.5% every year for someone to pick you a list of funds, you could probably replicate that exact service at Vanguard for a fraction of the cost. And even if they are a great firm that helps with your comprehensive financial plan, this fee structure is absurd if you have more than $1-2Million saved.
So, now let’s go back and discuss why sticking to a long-term low-cost portfolio is a fantastic idea, even if that idea has become commonplace.
Missing the best positive days in the stock market wrecks compound interest over the long haul. Incredible study here showing the results of missing the best days in the market over the last four decades.
The best positive days in the stock market often come during market downturns. The average up day in a bear market is substantially higher than the average up day in a bull market.
Sometimes I hear the following thought, “I’m going to go to cash, wait for everything to calm down. Then, I’ll go back in the market after this is over and things are calm.” The market doesn’t “calm down” and then slowly go back up. It usually hits a bottom and explodes up. Remember Christmas Eve in 2018. The market touched around the official bear market territory (20% down) and then closed slightly higher. The very next trading day (12/26 as the market was closed for Christmas), the U.S. large cap space went up 6% in one day. That’s a reasonably ok return for an entire year! And it happened in one day! Let me repeat-there is absolutely no scenario where you go to cash, wait for things to “calm down,” and then re-enter the market once it’s “calm.” The market can leave you in the dust while you wait.
Why does market timing investing not work?
I am strongly against market timing or using any technical analysis to make allocation decisions because of my firm belief in the markets being efficient. I believe the entire stock market is efficient, and the U.S. large cap space–S&P 5000–is very efficient. In an efficient market, an attempt to time or lower the impact of down markets will result in a proportionately lower return.
For example, if I hear a investing portfolio manager tout their record in 2008 of being able to move away from stocks and towards cash/treasuries, that sounds pretty impressive on the surface. But I want to dive deeper and figure out how soon they jumped back to investing in stocks. Then, I want to know how loyal they were to stocks during one of the greatest bull markets we’ve ever seen.
This is pretty jarring, but had you invested $1Mil in the S&P 500 in September of 2008, do you know how much you would have today? You probably know that the first six months were terrifying-you lost over 40%! You lost over $400,000! Had you somehow stayed put, though, you would have around $2.5Mil today.
My main in all of this: You can mitigate the potential disasters that come with a market crash in one of two ways.
Try to time the market or use “technical analysis” to alter your stock exposure as your analysis sees fit.
You can build a financial plan to meet your goals that allows you to continue investing during volatile times while still meeting life’s expenses.
Again, efficient markets. An attempt to lower the impact volatility has on your portfolio will result in a proportionately lower return. I believe #2 is in your best interests.
So now that I’ve said all of that, should you do anything right now?
I think this is a great time to talk about some investing action points that most of you could follow more closely. There are two things that you should review in a market crash like this.
If you’re retiring soon, how much of your portfolio will you need to spend in the next 5+ years? The same thought applies to a 529 account if your child is within a few years of college.
There is so much more to investing in stocks than the S&P 500-go overseas!
First point, I have absolutely no idea what the market will do in the next 2-3 years. The highest paid analyst on Wall Street doesn’t know either. We have a strong historical track record that a well-diversified portfolio will be up 5-10 years from today, but it gets a lot more murky with a shorter time horizon. So, if you need a certain amount of money from your portfolio in the next few years, we should avoid investing into stock with that part of portfolio. If you’re 62 and you’re retiring in 12 months and will start spending $10,000/month from your portfolio, we need to plan a safer route to provide for that income.
As you can imagine, that’s part of standard maintenance in a retirement portfolio. You might have 70% allocated to stocks and 30% to bonds or cash. We want to keep the next 5-10 years worth of income in safer vehicles, and we want to maintain flexibility as to where we take that income from based on what happens in the market. In essence, we’re making sound decisions to increase the odds of long-term success with your income plan.
Let’s talk about international stocks. About half of all public companies that you could invest in are outside of the United States. That’s an enormous amount of opportunity available to you. Why should you make sure to devote a portion of your portfolio to international and emerging market stock funds?
Sequence of returns, not just returns, matters. This is very true for anyone near retirement. Historically, there’s not a huge edge with international investing. If you look at any 30 year time period, U.S. and international stocks have provided pretty similar returns. So, why does it matter? Well, we don’t live life in 30 year periods. Even if you’re not near retirement, I’m sure you have exciting things you’re saving for that are coming up much sooner than that. That’s why not confining yourself to one country is a good idea. From 2000-2009, int’l and emerging markets crushed U.S. large cap stocks. Since then, the opposite has been true. Putting your entire stock portion in the S&P 500 sets you up for the possibility that 2000-2009 could repeat itself–that makes retirement more difficult. So, is the 30-year return between U.S. and int’l similar? Sure. But that means nothing to someone if they bet entirely on the U.S. and their first decade of retirement saw no real returns!
U.S. companies doing business overseas is NOT an excuse. Many like to say that you don’t need international investing exposure because U.S. stocks do so much business abroad. Yes, this is true, but the inverse is also true. International companies often have more U.S. exposure than U.S. has international exposure.
Risk of a serious multi-decade bear market. I don’t think the U.S. will face this. I’m still optimistic about the U.S. stock market, despite our all-time highs. But investing involves risk. That’s the deal. I’m sure few people in Japan expected no real return for decades, and that’s exactly what has happened in their market. Simply put, I don’t believe in allocating 100% of your stock position to one single country.
It’s fun to have predictions. It’s entertaining to watch people make predictions. CNBC and all financial media knows this. But be careful before making a decision you’ll regret in the long-term. And lastly, how about my prediction with Patrick Mahomes!