The news that the New York Stock Exchange had halted trading after the Dow Jones Industrial Average had dropped 2,000 points in the first 15 minutes of trading. 2 hours later the Dow had recovered by almost 800 points. After a day of ups and downs, the market closed down, lower than when trading had been halted.Looking at the 3 major US stock indexes we see
What should we do?
Based on my recent messages, you should expect me to say don’t do anything because your portfolio was designed to ride through market turmoil. You should also expect me to say that we are reviewing your asset allocation and buying stocks if your percentages drop below our tolerance level (aka rebalancing).
But there’s a dilemma we face when rebalancing portfolios during periods of significant market volatility. The dilemma is predicting the closing value when using open end funds that are priced on the closing prices of the underlying stocks.
As you saw above, the market swung wildly throughout the day. This is similar to what we faced during the 2008 crash, when the swings were so sudden. Because they often occurred late in the trading day, we are unable to rebalance using same day price estimates. As a result, we use the closing prices from the end of the previous trading day to evaluate the need for rebalancing.
Recently, when a client inquired about selling the market short, I explored buying options to hedge against these price drops. What I found was similar to previous research: current option prices were expensive, and you need the market to decline further before you would profit from your efforts.
Because research has shown that current market prices incorporate all known information and are the best predictor of future value, placing bets on changing prices is unprofitable, all too often.
In fact, if you think about it, the person selling the option believes that the price exceeds the expected cost, which is your profit.
Stay the Course!
All too often, when investment professionals talk about risk and reward in investing, they focus on the rewards and give little more than lip service to the risk. Current market activity provides a great illustration of what risk looks like. Investors who accept this risk should expect to be rewarded.
While many businesses are being hurt by the impact of the coronavirus, the damage to the economy and future economic output will be temporary. And because the value of your investments is tied to a long-term outlook, they will survive and recover, and you should expect to be rewarded for weathering the risk of this market downturn.
Stay with your investment plan because it was designed to meet your financial needs. The design takes into account the risk of market declines. It is built on evidence, i.e. research by world renown investment scientists whose work has been published and scrutinized by their peers. It is grounded in established economic theories. This avoids unnecessary costs and COMO (the cost of missing out when the market recovers suddenly – like it did beginning in March 2009).
And remember that we didn’t know when this downturn would happen. We still don’t know how severe it will be, or how long it will last. But we do know markets inevitably tank now and then; we also fully expect they’ll eventually recover and continue upward. Since there’s never a bad time to receive good advice, we hope you’ll be in touch if we can help.