How are you faring in today’s gyrating stock markets? As you read this, it’s equally likely that we’re experiencing days in a row of a steeply rising market or yet another anxiety-driven crash. My husband had just proclaimed his amazement at the continuing bull market when it tanked last week.
Maybe you were tempted to cash in all your savings in March, in the scary early opening rounds of COVID-19. Maybe you did.
That desire to avoid the downside at all costs is called loss aversion. Most have this tendency to some extent. It was first described by Nobel economist Paul Samuelson, who determined that losses hurt twice as much as gains feel pleasant.
Most people prefer not to bet in a coin flip where “heads” pays off $200 while “tails” costs $100. Count me in that group.
Risk aversion is helpful in protecting you from jumping off a cliff, but it can be harmful if it sways you to liquidate your investments in a bear market. You may feel good in the moment, but it’s a bear to find the right time to get back in the market.
Data show the market is substantially bullish in the one-, three-, six- and 12-month periods after five days of large sell-offs. This is good news: it would say you can take your time in getting back into the market.
The problem comes in trying to define the bottom in a pandemic. Financial advisor and CNBC contributor Josh Brown questions how you can know when the bottom is in a public health crisis.
“The underlying problem has not been fixed. I don’t see any meaningful bottom for stocks until we get some wins against the virus,” says Brown. The implication is that if you’ve liquidated, you’ll have to stay on the sidelines indefinitely because the feared crash may not yet have happened.
If selling off and trying to time your re-entry into the market is fraught, what about taking the opposite tack?
Let’s say you jumped in with both feet in early March’s first big sell-off. You cashed in bonds and corralled money accounts to invest your entire portfolio in stocks, stock funds, ETFs, REITs, gold, or whatever. You figured you’ll sell later at high prices and rebalance your portfolio.
Maybe. Now you’ve got the reverse problem: when to sell. This dilemma might be a tenable for a 30- or even 40-something, who perhaps can defer investment goals if the timing isn’t right to access funds for a car, tuition, or emergency.
It’s a difficult proposition for a retiree. If you need cash for a monthly budget or are required to withdraw funds for your annual IRA Required Minimum Distribution, you could end up selling in a bear market with permanent damage to your portfolio and retirement lifestyle.
The way to maintain your investment goals without falling prey to loss aversion or greed is to determine an appropriate asset allocation with your spouse, by yourself, or with an advisor. Then stick to it.
The amount you reserve in cash should be enough to fund an emergency — say six months of expenses. Your fixed income account should harbor at least enough money in the form of savings and laddered CDs and bonds to last an economic cycle — say six or seven years.
When you focus on the appropriate asset allocation for your age and stage of life, you are freed from panic over markets. The question I would like posed by a new client is:
What is the largest allocation to Fixed Income I can maintain and still have a superior chance for supporting my lifestyle beyond my life expectancy?
That is, give me a glide path through this pandemic rollercoaster.
— Karen Telleen-Lawton serves seniors and pre-seniors as the principal of Decisive Path Fee-Only Financial Advisory in Santa Barbara. You can reach her with your financial planning questions at email@example.com. Click here to read previous columns. The opinions expressed are her own.