Most people have heard the trope that financial markets are like a rollercoaster. But in March, the stock market took investors on the ride of their lives.
As countries around the world quickly shut down large swathes of their economies to contain the spread of COVID-19, Canada’s benchmark stock index shed around 35 per cent of its value.
It was a gut-wrenching moment — one that has prompted many to rethink their investment strategy.
According to a recent poll conducted by Ipsos for Global News, some 14 per cent of Canadians are changing their approach to investing amid the novel coronavirus pandemic.
But is that a good idea?
The answer, generally, is no, said Robb Engen, a fee-only financial planner based in Lethbridge, Alta., and author of the popular personal finance blog Boomer and Echo.
If you are investing for a long-term savings goal, have put your money in a wide variety of investments, and can stomach the ups and downs of your portfolio, then riding out a market crash like the one we just saw is the name of the game, Engen said.
Whenever stocks take a dive like the one markets experienced in the first three weeks of March 2020, there is always the impulse to cut one’s losses and cash out, said David Dyck, chartered investment manager at WealthBar, a Vancouver-based robo advisor.
The problem with that, though, is that it’s very difficult to know when to get back into the market — and according to Dyck, history shows that missing out on some of the days when stocks are rallying generally costs investors more, in the long run, than whatever they saved by avoiding part of the stock plunge.
An investor who missed just five of the best days of the S&P 500 stock market index between 1980 and 2018 would have ended up with 35 per cent lower returns, according to research by Fidelity Investments.
And the trouble is, “you just don’t know when the good days are going to happen,” Dyck said. In fact, he added, the good days are “often surrounded by the bad ones.”
So far, this has held true for the current market gyrations. Canada’s main stock index closed its best week in over a decade just before the Easter long weekend.
Another study, by IG Investors Group, compares the fate of a hypothetical investor who invested $100,000 in stocks mirroring the S&P 500 at the start of 2006.
If the investor had stayed in the market throughout the 2008-2009 financial crisis, they would have ended up nearly doubling their money in the span of a decade. By contrast, if the same investor has sold everything at the bottom of the market in 2008 and jumped back in one year later when the recovery was well on its way, they would have grown their portfolio to just $114,000 over the same 10 years.
“By staying invested — yes, you’re capturing all that downside, but you’re also getting every single good day on the markets. And that’s why staying invested is the wisest thing to do,” Dyck said.
But what if the latest market conditions had you losing your sleep? And what if you lost money you actually need right now?
Sometimes changing investment strategy after a market plunge can make sense, Engen said. And sometimes, what you may want to tweak has nothing to do with your investment allocation, Engen and other financial experts told Global News.
Reasons for changing your investment strategy:
1. You overestimated your risk tolerance
Often, advice about staying the course through financial meltdowns is based on the assumption that you accurately estimated your risk tolerance, Engen said. But it’s hard to really know just how you’re going to feel checking your monthly investment statement and seeing double-digit losses until it actually happens, he added.
Especially during the last 10 years, which saw the longest bull market in history, it’s been easy for investors to overestimate their risk tolerance, Engen said.
While stocks hold the promise of higher returns over the long term, they’re also prone to steep ups and downs. By contrast, other lower-risk investments, like bonds, deliver lower returns but are also much less volatile.
“Perhaps you’re not a 100 per cent equity investor,” Engen said. And that’s OK.
An investment portfolio that’s a mix of stocks and bonds may be a better fit, Engen said.
A much more reasonable approach for many investors is a balanced portfolio of 60 per cent stocks and 40 per cent bonds, he added. For example, Vanguard’s Balanced ETF Portfolio (VBAL) was down just 18 per cent at its lowest point in the recent crash, compared with a 34 per cent plunge for Vanguard’s All-Equity ETF Portfolio (VEQT), he noted.
Still, it’s usually best to avoid changing your investment strategy right in the middle of market turmoil, said Markus Muhs, investment advisor and portfolio manager at Canaccord Genuity in Edmonton.
“During a hurricane, it’s really hard to make those decisions to try to change your direction,” he said.
“Then you’re just trying to batten down the hatches and try to make it through this.”
But when stock prices have recovered somewhat and the waters aren’t quite so choppy, you may want to use your newly acquired self-awareness of your actual risk tolerance to reset your investment compass, Muhs said.
“Maybe now’s the time to look at the markets,” he added, noting that stock prices have bounced back to levels that were all-time highs just two years ago.
2. You took on too much risk with a short-term investment
Another good reason to rethink the way you invest: you lost money you’re going to need now or in the next short while.
“If you don’t have at least a five-year window of that money, it shouldn’t be in the market,” Engen said.
And you may want that time horizon to be longer than 10 years if you’re thinking of investing 100 per cent of the funds in stocks, said Muhs.
But Muhs is skeptical of investing in the market for something like a downpayment on a house even if you do have a time horizon of more than 10 years.
That’s because almost every young client Muhs has worked with has ended up purchasing a home sooner than planned because “some kind of opportunity came up,” he said.
It’s easy to imagine some first-time buyers seeing exactly that kind of unexpected opportunity right now, after the pandemic froze the spring housing market, Muhs said.
In general, “in terms of a home purchase, saving cash is king,” he said.
Engen suggests parking money for a downpayment in a savings account with a competitive interest rate, where it will at least keep pace with inflation.
Still, homebuyers can still benefit from stock market growth if they have some extra cash at hand, he added.
When Engen was saving up for his own home about 10 years ago, he did use some investments to boost his down payment. That, however, was merely a top-up, he said. If the stock market has been down when he needed the cash, he would have been perfectly fine without touching his investments, he added.
“I can’t imagine putting your entire down payment into the market,” he said.
3. Your investments aren’t diversified enough
Diversification means putting your investment eggs in many different baskets to limit the risk tied to any single company, industry or country.
No matter your ability to tolerate the ups and downs of the market, it’s always good to have a broadly diversified portfolio, Dyck said.
“If you’re an aggressive investor, instead of holding five stocks, you hold a basket of funds that have dozens or hundreds of stocks at different businesses and regions,” he said.
If you’re a risk-averse investor, you hold a mix of fixed-income securities that can provide better returns than a savings account without the wild ups and downs of stocks, Dyck said.
Not enough diversification can result in your investments performing even worse than the overall market in a downturn.
“It’s about making sure you have sufficient diversification to manage risk at any level of risk,” Dyck said.
Dividend investors should also be thinking about whether or not they’re diversified enough, Muhs said, noting that the economic impact of the current pandemic carries risks for dividend-yielding companies in a number of industries, from airlines to utility companies.
U.S. aircraft maker Boeing, for example, recently told investors it could be years before investors see another dividend payout.
“Dividends are a nice side effect of investing,” Muhs said. “But it should never be the modus operandi of your investment style looking for dividends.”
4. You’re paying too much in investment fees
If you have an investment advisor who picks stocks, bonds or mutual funds for you, you may want to take a hard look at how your investments fared compared to the overall market, Engen said.
“What you hear a lot from those advisors is, ‘Don’t worry, you can get all of the upside in the market, but I’ll protect your downside,'” Engen said.
Take a look at your latest statements, Engen said. If your advisor didn’t live up to expectations and you’re paying a steep fee for their services, consider whether you wouldn’t be better off managing your investments on your own with low-cost options that rely on index funds that just mirror the market’s ups and downs, he added.
5. You have money to invest
If you’re a new investor hoping to jump into the market, now’s a good time to do so, Muhs said. The same holds if you can afford to ramp up your contributions, he added.
Muhs sees the recent plunge in stock prices as a good opportunity for older millennials, most of whom likely didn’t have any money to invest in the last bear market a decade ago.
Now, many millennials are “finally at a stage in their career where they can save more or they’re just being paid a bit more.”
“Having a drop of the markets is … great for them.”
Go in knowing that investments are much cheaper than they were a few months ago, but not believing that they can’t go down again in the near term, Dyck said.
“Don’t worry about short-term declines because, long-term, your best bet is to have your money invested as soon as possible for as long as possible,” he said.
And that’s why, if you have a lump sum of money to invest, it’s best to go all-in, instead of dipping in gradually, Dyck added.
6. You’re retired and have money you can afford not to spend
Engen recommends retirees have at least five years’ worth of living expenses in cash. This, he said, ensures they’ll be able to ride out an even prolonged period of lower prices in the market without having to draw on their investments and crystallizing their losses.
Thinking you can recover your losses from a big market crash within three years is probably a safe bet, but “five years is just that extra built-in protection,” he said.
If you don’t have that plush cash cushion, though, and must tap your portfolio, it may be a good idea to at least scale back the number of your withdrawals, if you can afford it, Engen said.
It helps, this year, that Ottawa recently passed legislation lowering the minimum amount for mandatory withdrawals from a Registered Retirement Income Fund (RRIF) in 2020 by 25 per cent.
Baby boomers may be the investors facing the greatest investment challenge in the current crisis, Muhs said.
On the one hand, in the 1980s, when boomers were starting families, buying homes and needed to borrow, interest rates were “sky high.” On the other hand, now that boomers have savings they need to turn into a reliable income stream for retirement, interest rates are at near zero, with few options but the volatile stock market to generate decent returns.
“It’s a real challenge,” he said.
The findings about Canadians changing their investment strategy are part of an Ipsos poll conducted between March 24 and April 2, 2020. The survey is based on a sample of 2,400 Canadians interviewed online. The poll is accurate to within ± 2.3 percentage points, of what the results would have been had all adults in each of the markets aged 18+ been polled. The credibility interval will be wider among subsets of the population. All sample surveys and polls may be subject to other sources of error, including, but not limited to coverage error, and measurement error.