The blooom Strategy Regarding Market Drops
What is blooom’s strategy when the market drops?
Don’t panic. It’s not a decline in your account until you take action. That said, our hope is that our clients begin to think of market drops as an opportunity to get their favorite investments “on sale.” During these market “sales” if you have room in your budget - this is the time to consider INCREASING your 401k contributions to take advantage of these temporarily lower prices.
On blooom’s side, we will continue to rebalance our clients’ accounts with a precise strategy—extracting some of your money from the investments that have been doing the best and adding to the investments that have done the worst.
So, in cases where the market has dropped, we could be trimming from your bond positions (if you have any) and adding those funds to the stock funds that have declined in value. This may surprise some folks - but rebalancing dramatically increases the chances of buying low and selling high.
Why keep contributing when the market is going down?
Think of it like any sale when shopping... Wouldn’t you typically prefer to buy something for less than you might have yesterday? Stocks should be treated no differently, yet they are. A down market is a stock sale. Not only should you continue contributing, you should also consider contributing MORE! These are fantastic opportunities.
Why not sell now and buy back later when things look better?
How exactly does one define “looking better”? What often happens when individuals attempt to time the market like this is that they find it impossible to know when it is the right time to get out AND get back into the market. Let’s take a couple of different scenarios for example:
Scenario 1: Investor A decides the market has had a good run and he/she would like to sell out of stocks and sit on the sidelines to wait for the coming correction, which he/she feels is coming any day…6 months later, stocks have continued to rise about 10% higher. Investor A starts to think maybe their hypothesis was wrong, so they buy back into stocks. One week later, the market drops 5%. Investor A now thinks this is it. This is the correction! He/she sells everything again. But that 5% dip is followed by an 8% rally over the next 3 months. If Investor A had just done nothing at all, he/she would have been far better off, even though the value of their acct would have seen a few dips along the way.
Scenario 2: Investor B – Like investor A, investor B is starting to feel like it may be a good time to lock in some gains and head to the sidelines. The market continues to hit all-time highs and it seems we’re overdue for a major correction any day now. Investor B sells all his stocks. The very next day the market begins a downward spiral that lasts a month. Over that single month, the market drops more 20% and Investor B feels like a genius. Headlines all over the business news media indicate that this decline could likely be another 2008. Panic floods Wall Street for several more weeks while Investor B continues to sit comfortably in cash. But suddenly, a month later things abruptly turn around. The market begins to rally and rises 5% in one week. The next week another 5%, but the headlines are still extremely negative. Investor B is convinced we haven’t seen the end and refuses to be tricked back into the market. Over the following 6 months, the market rallies more than 30%, indicating the abrupt 20% correction would have actually been an incredible buying opportunity. Having missed this opportunity, Investor B is still hesitant to reinvest his money in stocks. He/she is convinced that this rally has simply come too far too fast. The market rallies another 10% over the following 6 months. Investor B finally decides to reinvest, just as the rally slows down…While he/she nailed the timing of the crash, what proved impossible was to then also nail the recovery, which often happens very quickly and robustly after a decline, but not always.
Both scenarios (in some form or fashion) highlight several important facts about market timing. Markets do not move straight up and down. Corrections and rallies typically take longer than a single day or week to develop and it is impossible to time both correctly with any kind of consistency. Historically speaking, when investing for the long-term, doing nothing and staying disciplined (leaving your emotions out of the equation) has always proven to be the way to go.
Do I need to tinker with my allocation when the market is going down?
You may be tempted to, but this would amount to a form of market timing. Instead of panicking and changing your strategy, sit tight knowing that the long-term strategy we’ve put in place for you already takes into account that there will be many, many market corrections between now and when you retire. And that is a good thing! Also remember that with blooom, your investments will become more conservative as you get closer to retiring, which basically means we make these allocation adjustments for you automatically, based on a preset strategy instead of emotion, which is the number one enemy of an investor.
How about BEFORE the market is going down?
Not unless you have a psychic power or a crystal ball. There is not a single investor that has ever been able to accomplish getting in and out of the market at the “right” time. Markets are not predictable, but based on what’s been happening for hundreds of years, we can assume that the long-term return will be positive. Just hold onto your horses...
Why not put everything into a bond fund and wait it out?
The idea of waiting it out means you have to make a wild guess on when to get back into stocks in the future and historically, the best times to buy back into stocks after corrections are when things look the worst. It becomes a guessing game that simply cannot be won. Since there is not a single example in US history of a broad market correction that was not followed by a recovery, why bother trying to play a guessing game when you could instead just stay calm and ride it out? With years and likely decades until you plan to retire, it’s important to understand that volatile markets and corrections are great opportunities and not reasons to panic and change your strategy. History shows us this has always been the winning approach for investors.
Why not put everything into cash and buy back later?
This amounts to market timing. Why would you prefer to start buying again only when prices have come back up? Just like you would with toilet paper at Costco, stock up on stock during the sale. No one would ever purposely wait until a Black Friday sale ended to buy a new TV that was being offered at 50% off…Rather than cutting contributions, these are opportunities to increase them.
Why not buy the best performing funds from last year?
When it comes to performance of an investment, recent performance is based on the much-too-recent past and is often one of the worst indicators of future performance. For example, investing in a fund after it has been performing at the top of its category is often the absolute worst time, because the periods following tend to be worse. It’s important to remember that an investment’s rate of return is variable and just because a fund has performed well recently, does not mean that performance will continue. In fact, it is often the worst way to pick an investment. Various studies have shown that top performing funds almost never continue to remain top performers even one year later.
I own 10 different funds therefore I’m diversified and safe from market fluctuations.
Truth is, diversification is about much more than the number of funds. Selecting 10 funds without considering the asset classes you’re investing in, the risk characteristics of each asset class, you’re not investing appropriately, you’re guessing, and you could be putting too many (if not all) of your eggs in one basket. Proper diversification involves spreading out risk among asset classes that expose you to different levels of risk and return potential, and have different attributes. If you decide to eat 10 cookies (even if they are different types of cookies) every night for dinner instead of a well-rounded meal, it won’t be long before your health starts declining, although this does sound delicious…
The “experts” are saying it’s going to get worse! Shouldn’t I ditch the fund that aren’t performing right now and put them into the funds that are?
The truth is anyone can say the market is going to get worse and be right at some point. When they are right, we praise them for it, ignoring all the times they’ve been wrong prior. This is sort of like a psychic telling you he or she had a vision that you will drink water at some point in the next week. Of course you will. You have to. This is just a fact of life.
When it comes to performance of an investment, recent performance is based on the past and is often one of the worst indicators of future performance. For example, investing in a fund after it has been performing at the top of its category is often the absolute worst time, because the periods following tend to be worse. It’s important to remember that an investment’s rate of return is variable and just because a fund has performed well recently, does not mean that performance will continue. In fact, it is often the worst way to pick an investment.
The political landscape makes me nervous. What should I do?
The one consistent in the history of the market and politics is that “the current political landscape” has almost always been a source of concern—no matter who you are or where you stand politically. Fortunately for investors, the market has largely shrugged off both good and bad political regimes here in the US.
The market is overvalued. I’m going to sell everything and wait until things settle down.
Wouldn’t this be awesome?! Who wouldn’t want to sell out of everything at high prices then wait and buy back in right as the market bottoms and turns back up again?! Unfortunately, reality bites.
Turns out that no human on planet earth and no IBM-Watson-like supercomputer has ever been able to pull off market timing on a repetitive or consistent manner. It is also impossible to know if the market today (or any other day) is really over-valued.
There are, of course, various indicators that attempt to show the market valuation but the problem is that over-valued markets tend to get WAY over-valued before a correction. Moreover, even if you do get lucky and sell out right before the market topples, you have to be right for a 2nd time in a row to be able to buy back in when things are lower. As we often say - the market never rings the “all clear” siren to let people know when it is safe to get back into the market.
The rest of the world is crazy. Should I put all my money in the US market?
While that may seem true at times, there will be other times when the US market is in turmoil and the rest of the world is not, or is to a much lesser extent. In a long-term portfolio, diversification spreads out risk among different types of investments throughout the world that tend to move independently of one another over long periods. This lets you experience the long-term upside of fast-growing, higher-risk economies for example, while reducing the risk of investing ONLY in those countries.
I see the S&P is up X percent… why isn’t my 401k account up the same amount?
The S&P 500 is a market index representing 500 Large US companies. If you’re invested 100% in an S&P 500 index fund, you’re returns would be nearly identical the actual S&P 500. But if you’re portfolio is diversified, like the one blooom has provided, more than half of your account is probably invested in other asset classes, like small and mid-sized US companies, International companies, real estate, bonds, etc. When it comes to performance, no properly diversified portfolio should be compared to any single market index, like the S&P 500, Dow, or Nasdaq. It’s like analyzing a chocolate chip vs. the entire cookie.