Maybe you saw the coronavirus pandemic and the subsequent economic devastation that it would cause. Maybe you knew the stock market would fall dramatically. Or perhaps you missed the initial selloff but sold stocks before the worst of the carnage in March. What a relief. You were sitting in cash while the market dropped 35% in six weeks, the fastest decline on record.
When the market surged in April, you called it a dead cat bounce. Of course there would be a bear market rally after the dramatic selling in March. The best and worst days (or months) occur during bear markets after all. Best to stay on the sidelines while volatility is raging. You had plenty of time to get back in the market. How could there not be a better buying opportunity? 30 million Americans filed for unemployment claims and huge swaths of the economy were completely shut down. This was supposed to be economically worse than the Great Depression.
Now? Now you believe the market is clearly overbought and due for a major correction. How could stocks possibly be worth the same as they were pre Covid-19? The Fed is propping up the stock market with free money, and eventually, we will have to pay the piper. It is best to wait for that buying opportunity.
But here’s the thing … it may never come.
And if that buying opportunity does come, the news will be so negative that you won’t want to buy stocks. Believe me. In March, I followed up with a lot of investors who were sitting in cash last year because the market was “too high.” Not a single one of them decided to buy stocks in March.
Cashing out and sitting on the sidelines may be an investor’s worst dilemma.
Buy back too soon, and there’s immediate pain for not waiting longer. Wait too long, and the pain is greater than the regret of missing the upside. Now there’s a chance you are buying back in at the top, right before the NEXT downturn. There is no way to win in the short-term.
Losses hurt twice as much as gains feel good. It is understandable to want to avoid the pain.
Over long periods of time stocks have returned on average 8-10% per year. Perhaps easy money and low interest rates means those returns will be a little lower going forward. Or maybe not. Either way, the only way to earn market returns is to jump on the train and stay for the ride.
Do yourself a favor and don’t let yourself get in to this dilemma in the first place.
You will need to use a few tricks to help yourself stay invested. First, run the numbers to figure out how much you need to meet your financial goals. This requires making assumptions about your future expenses, the rate of inflation, and yes, an average rate of return for your investments.
Then, figure out how much risk you can take and still sleep at night when things get tough. A severe bear market for stocks is a 50% peak to trough decline. Doing a back of the envelope calculation, figure out what dollar decline you would see on your portfolio if your stocks were cut in half. If that dollar amount is too much, adjust the percentage of your portfolio in bonds to reduce that decline to an acceptable level.
Even after doing all of that, you may need to hire someone to help you stay the course. The human brain is not wired to make long-term decisions with money. Our instincts, which ensured the survival of our species, cause us to react to immediate danger. Don’t beat yourself up. Investing is hard. It becomes much harder when you get yourself into this dilemma.