The S&P 500 fell 7.6% today, coming within a single percentage point of bear market territory after two weeks of high volatility brought on by the Coronavirus outbreak. It’s very understandable why people are panicking right now. If you had $100,000 in the market a few weeks ago, you’ve lost about $19,000 in just a couple of weeks because of some virus that only ~600 people in the US have contracted so far. That’s an entry level brand new car, or four months of living expenses for an average family, that simply disappeared. If this virus can do that much damage so quickly, imagine how much more it can do in the coming months.
I spent the weekend in Cambridge doing an on campus seminar for a Behavorial Economics class I’m taking, and naturally this topic came up. And one comment that I was shocked was made several times (and I’ve seen in articles all day today) was “buying stocks right now is like trying to catch a falling knife”.
There is only one problem with this discouraging and pithy saying: It’s completely false.
The sentiment behind this statement and all of the hysteria in the media right now regarding this bizarre market behavior is that there is still a lot more room for the stock market to crash, and you should get out now while you can. Essentially, that is saying that short term swings in prices should determine whether or not you buy into the stock market. Assuming you aren’t a day trader or retiring in the very near future, that makes no sense. There are only two kinds of risk that matter when it comes to long term investing: the likelihood of permanent loss of capital, and the likelihood of a subpar return.
COVID-19 doesn’t change either of those risk characteristics over any sort of reasonable investing timeline. It is very true that it has already impacted our economy, and those impacts are likely to continue and probably even get bigger, especially as more large events get canceled and people avoid public places. Stocks may fall significantly farther than they already have. We may even enter a bad recession. But will companies all go under and stocks go to zero permanently? I certainly don’t think so, nor I suspect does anyone else who thinks about it for more than a passing minute. Therefore there is no increased risk of permanent loss of capital.
“But returns might be low, or even negative!” Sure, I would be a fool to try and predict short term market prices. Stock prices absolutely might continue to go down in the coming months. True investing though isn’t about the short term swings in prices, it is about maximizing returns over the long term. Performance over a time horizon of less than five years simply shouldn’t concern anyone who doesn’t absolutely NEED to use that money within that time. Your portfolio’s performance must be evaluated over the course of decades. So which investment will likely have a higher return over a ten year time horizon from your current options: a stock market index that is almost 20% cheaper to buy right now than it was a few weeks ago, or a government bond that pays 0.499%? Hopefully that is rhetorical.
To illustrate this, let’s look at October 17, 2008, one month after the the housing market collapse and Lehman Brothers bankruptcy. At that point, the market had fallen 23%, and Warren Buffett wrote his famous “Buy American. I Am.” article encouraging investors to buy US stocks. Now, things got worse from there (which he said would probably happen) and the market fell another 26% before it began rebounding. But if you bought when Buffett wrote that article, you would have ridden a nasty wave for a few months and then tripled your money in the time since. You don’t need to time the market. You just need to keep your head clear when it’s being a bit irrational.
It was somewhat ironic that my fellow Harvard students this weekend were so panicked since we were studying how psychological biases cause people to make irrational decisions. Selling stocks that you otherwise intended to hold for the long term right now because of the wide spread panic is certainly irrational. As is being afraid to buy. There is perhaps no better example of how intelligence doesn’t determine investing success, temperament does.cherrymodels.tv