Host of the popular Money For the Rest of Us podcast David Stein, answers the questions everyone has been asking about investing during the pandemic.
There are few times in our lives when we can genuinely say, “This time is different.” The current global economic shutdown due to the novel coronavirus pandemic is one of those times. Unemployment rates are skyrocketing as non-essential businesses close and individuals shelter in place to slow the pandemic’s spread. The U.S. will most likely see unemployment rates of over 10% by early May. The global economy is on course to suffer its worst economic contraction since the end of World War II.
This pandemic is different from prior pandemics both in terms of how quickly it has spread around the world and how aggressively governments and central banks have acted to invoke policies and implement programs to slow the rate of transmission and attempt to soften the economic blow.
Stock markets around the world sold off significantly as the pandemic took hold but they have also mounted some impressive rallies. The day-to-day volatility can be both painful and confusing for investors. What should individuals do, if anything, with their investment portfolios? Should they reduce risk by selling stocks? Should they buy more stocks in order to rebalance their portfolios back to their long-term target? Or should they patiently ride out the storm without making any changes?
To answer these questions, we must first recognize no one knows when the pandemic and economic turmoil will end. We can, however, be quite confident that the pandemic will end because all pandemics eventually do.
Pandemics slow when the rate of patient recovery outpaces the rate of new infections. Social distancing, quarantines, widespread testing, contact tracing, and group immunity lead to an exponential drop in new cases. More effective treatments to assist the ill are discovered. Vaccines are developed.
Models used to estimate when the pandemic will slow rely heavily on what is happening now as the pandemic takes its course rather than using data from previous pandemics. That means there are no historical probabilities to give us a high degree of confidence as to when our lives will return to normal. It could be three months, six months, or a year or more.
Given the extreme uncertainty, there is no way to accurately forecast what will happen or determine an optimal asset mix to position for what lies ahead. Instead, investors must choose an asset allocation that they are comfortable with when considering two opposite events:
- The stock market falls significantly from here because the economic shutdown lasts much longer and is more severe than the consensus view.
- The stock market rallies because a vaccine and effective treatments are discovered, and everything is back to normal by mid-summer.
Personal comfort might seem like an odd way to choose an investment mix. Comfort is a feeling. It is not an optimized solution. Comfort means we will not be personally harmed and overly regretful if either financial scenario takes place.
For example, a couple who is nearing retirement and has 75% of their retirement savings invested in stocks might have to delay their retirement if stocks fall another 50% from these levels. That could lead to significant regret and discomfort. That couple might want to reduce their stock exposure.
Conversely, a young investor with many years to retirement would be more comfortable with such losses because she has many years left to save and invest before she needs to access her retirement portfolio. The young investor might want to incrementally increase her allocation to stocks to take advantage of more attractive prices.
Making incremental portfolio changes is a helpful strategy for dealing with investment uncertainty. It satisfies an inherent need to act but does so without being rash. Incremental actions also give us time to assess how we would feel if markets fall or rally from here.
Our desire to know what will happen often leads us to seek advice from those who say they can accurately predict what financial markets will do and when this crisis will end. There isn’t anyone who can do that. No one knows. There is no algorithm. This time really is different. Consequently, we have to make investment choices based on the potential personal harm and our feelings of regret. That is the human thing to do.