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" data-orig-size="1880,1253" data-image-title="silhouette of unrecognizable surfer on board" data-orig-file="https://smallivy.files.wordpress.com/2023/03/pexels-photo-5441742.jpeg" data-image-description="" data-image-meta="{"aperture":"0","credit":"","camera":"","caption":"","created_timestamp":"0","copyright":"","focal_length":"0","iso":"0","shutter_speed":"0","title":"","orientation":"0"}" data-medium-file="https://smallivy.files.wordpress.com/2023/03/pexels-photo-5441742.jpeg?w=300" data-permalink="https://smallivy.com/2023/03/12/should-i-sell-and-wait-out-the-crash/pexels-photo-5441742-2/" alt="" class="wp-image-23178" data-large-file="https://smallivy.files.wordpress.com/2023/03/pexels-photo-5441742.jpeg?w=723" />Photo by Kammeran Gonzalez-Keola on Pexels.comDear SmallIvy,
I’m curious what your thoughts are for the market this coming year. People keep saying the market is crashing or going to crash and my husband wants me to move a good chunk of my 401k temporarily to a money market fund to ride things out. I know it’s probably an involved answer but I’d love to know your basic thoughts.
-Tricia
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Dear Tricia,
It is natural to want to try to avoid stock market downturns, but trying to sell out before a decline and then buy back near the bottom is an example of market timing, something that study after study has shown does not work out well for investors. In fact, index investors should be making a long-term return of about 10%, but most manage only 3-4% because of trying to time the markets. It isn’t that I would be surprised to see a decline this year or next given the Federal Reserve’s recent rate tightening actions. It is just that the exact timing of such moves is difficult to predict and the danger of missing out on a big move upwards is a far bigger risk than that of a market drop. The markets have also already gone down substantially since the end of 2021, so a lot of the decline may already be priced into stocks.
You see, the large returns of the markets aren’t the result of a slow, steady upward move. Movements up occur over a few weeks or even days. You might see nothing happen for most of the year and then stocks go up 30% in a few days after some big news comes out. If you’re sitting in cash on the sideline and miss these days, your returns will suffer dramatically. Yes, I wouldn’t be surprised to see us lose on the order of 10 to 20% as the Federal Reserve continues to raise rates and the recession we’re in gets extended and deepens, but it is also possible that some big event might occur causing stocks to shoot up. They also have some pent-up price pressure after inflation has caused the price of everything else to rise but stock prices have not yet participated.
Invest based on time frame
The Efficient Market Theory says that everything that is known about the markets is already priced in. Certainly the markets know about the inflation rate, the Fed’s tightening, and the war in Ukraine. These factors have already been priced into stocks to the best of the collective market’s ability. This means that any moves upwards or downwards from now would be pure chance. Stocks are equally likely to rise or fall.
We do know to expect a substantial market decline of maybe 20 to 40% about every five to seven years based on the statistics of the market’s past. These declines usually recover within a year or two. This means that you should always expect to see maybe 30% of your portfolio value wiped out and then a wait of a year or two to see prices recover back to where they were. If your investing time frame is about ten years or more, you can probably stay invested mainly in stocks and feel relatively secure. If you need money within about 10 years, you should start shifting money over to bonds and other fixed income securities. You might also think about shifting some funds into cash, particularly if bank rates are reasonable like they are becoming now.
As you get to short time periods, the returns between stocks and bonds also become more comparable. Invested for 30 years, a broad market stock fund will trounce a broad market bond fund. Over ten years a stock fund will normally outperform but not always. Over five years it’s really a toss-up. This is another reason to start moving some of the money you’ll be using within ten years or less into bonds: You might do better in bonds than you will in stocks. If you buy into both, you’re sure to have some money in whatever does best during the period.
Note that these ideas are valid regardless of what the market is doing. We don’t try to guess when and whether bonds or stocks will outperform because that is a random event. Instead we adjust our portfolio based on our timeframe and personal risk tolerance regardless of what we expect the markets to do.
Invest your age in bonds
One idea popularized by Vanguard founder Jack Bogle was to invest a percentage equal to your age in bonds and then invest the rest in stocks. So, at age 50, you’d be 50% in bonds and 50% in stocks. At 60, you’d be 60% in bonds and 40% in stocks. The idea is that you’d shift to the more predictable fixed-income assets as you started to need the money. A portion is left in stocks since you’ll still need asset appreciation to keep up with inflation. Because people are now living longer, this has been adjusted to “invest your age minus 10% in bonds.” So, at 60 you’d be 50-50 and at age 70 you’d be 60-40 bonds-stocks.
In general, the allocations you use should be based in part on your personal tolerance for volatility. (Volatility is the level of fluctuations in your protfolio value. Everyone loves upwards volatility, but no onle like downward volatility. A high volatility portfolio will move both ways, however.) Persoanlly, I don’t mind a rollercoaster ride since I know I’ll see a recovery and my portfolio climbing to higher heights if I just stay invested. I therefore stay 100% invested in stocks (actually about 15% is in REITs, which perform very similarly to stocks) since I know that will provide the best returns over long periods of time. Other people don’t like such a wild ride, so they may keep 20-30% in bonds even in their twenties. They’ll be giving up some return, but the bond positon will offset some of the volatility in the stock position, leading to a smoother ride.
You can also reduce some of the volatility without giving up return. You do this by investing in different markets. For example, you can invest in both large and small-cap stocks. Investing in either long-term will provide returns in the 10-12% range. If you invest in both, you’ll get the same returns but also see less volatility in the value of the portfolio. The large stocks and small stocks will not always move the same direction, so the effect of owning both will be to reduce volatility while providing the average return of the combination. Buying US and non-US stocks is even better at reducing volatility. Buying both stocks and REITs is also a good combination since stocks and real estate don’t always perform the same.
Want to learn a lot more about stock investing?t
If you want to go from being one of the crowd to a sophisticated investor, pick up a copy of SmallIvy Book of Investing: Book 1: Investing to Become Wealthy. In there I explain a lot more about things like growth and income investing. Having this kind of knowledge will help you get that extra edge you need to best your peers. There is also lots of material on how you should be managing your money at different stages of your life to grow your wealth. Please consider grabbing a copy and checking it out. I think you’ll be glad you did.
Weathering downturns
Even though the right thing to do, it’s no fun to ride out a downturn in stocks. You’ll see your portofolio value drop with each new statement and positions go from gains to losses in some cases. This can be difficult psychologically. Some ways to cope include:
- Check prices rarely. You really don’t need to monitor things closely, so if you don’t want to look, just ignore things for a few months.
- Add to your positions. Instead of looking at your losses, look at the bargains stocks become during these times. Everything, good and bad, goes on sale. If you have income coming in from your job or another income source, use this opportunity to add to your portfolio.
- Rebalance. After a substantial downturn, rebalance your portfolio by shifting money from the things that did well (or not as badly) to those that really got killed. This will normally help your portfolio recover more quickly since the stuff that was really beaten down will normally perform better than the assets that were not.
Have a burning investing question you’d like answered? Please send to [email protected] or leave in a comment.
Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
