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En español | The coronavirus bear market has probably left a smoking crater in your retirement portfolio. In only 23 trading days, the S&P 500 index plummeted 33.9 percent from its high on Feb. 19. Though it rebounded a bit, it still ended the first quarter down just over 20 percent.
Bear markets are always painful, but after an 11-year bull market, this bear is particularly excruciating. That said, no bear market should go wasted. There are lessons to be learned going forward.
1. Stocks really are volatile. We all knew this from an intellectual standpoint but we so enjoyed the past 11 years that we pushed this knowledge back into the attic of our mind. And there it sat, just collecting cobwebs — until Feb. 19.
2. Our risk tolerance wasn't as high as we thought. Stockbrokers and financial planners typically require new clients to fill out a risk tolerance questionnaire before they make any changes to a portfolio. But asking people how they would feel if their stocks lost a third of their value is a whole different exercise than asking how they feel after it happens. We thought our risk tolerance was much higher in January than we did in March. Experiencing a bear market makes us view risk in a new light — which is why risk-tolerance questionnaires don't work.
3. Bonds should be boring. We don't learn the wonders of being boring until the market gets more exciting than we'd like. You want your bond funds to zig when the market zags, and high-quality bonds and bond funds do just that. This quarter, the iShares Core U.S. Aggregate Bond ETF (AGG), comprising about 63 percent U.S. government and 37 percent investment-grade corporate bonds, gained 3.1 percent, including interest. On the other hand, those shooting for high income through junk bonds instead of high-quality bonds gained unnecessary pain. Junk bonds, which Wall Street politely calls “high-yield bonds,” are IOUs issued by companies with less than stellar credit ratings — making them very risky when the economy looks shaky. The SPDR Bloomberg Barclays High Yield Bond ETF (JNK) lost 12.74 percent, including the interest received. You need high-quality bonds to be a shock absorber.
4. We take risks we don't need to. We are 11 years older than when the financial/real-estate crash bottomed on March 9, 2009, and we have less time to recover than we did then. As you approach your financial goals, it makes sense to pare back risk, because you won't have time to make up big losses.
5. We hate buying stocks when they are on sale. I know for a fact that stocks ended the quarter priced 20 percent less than we ended last year. Yet many of us are suffering from what I call Portfolio Pandemic Panic (P3) and desperately want to sell. Don't succumb to P3. It turns out that buying stocks when they decline has worked well in the long run.
6. We are not efficient learners. This plunge was caused by COVID-19. Though it is completely different from the first two plunges of this century, none of these lessons is new. The next plunge also will be completely different and offer the same lessons.
As I said earlier, no good market plunge should go wasted. So here's what to do now:
1. Pick an asset allocation you can live with and rebalance. In its simplest form, an asset allocation is the amount you have in stocks and bonds. My target allocation, for example, is 45 percent stocks and 55 percent bonds. When you have an asset allocation you can live with, buy stocks when they are on sale — like now — to get back to your target asset allocation. I had to rebalance twice by selling my bonds and buying more stock index funds to get back to my 45 percent target. Simple? Yes. Easy? No! It's never psychologically easy to buy stocks when they are down.
2. Get out of expensive, underperforming funds. I tell people “I'm sorry for your loss” but let's make the most of it. You may have some expensive funds in your taxable accounts you didn't want to sell because of the taxes that would be due on those gains. The coronavirus crash may have solved this for you, as many of the gains have vanished. Replace these dogs with low-cost diversified index funds.
It was so easy to be a good investor for 11 years. It's a lot tougher in a down market, and we still can't say with certainty whether the last few days of March were the turning point or just a short reprieve.
Allan Roth is the founder of Wealth Logic, an hourly-based financial planning firm in Colorado Springs, Colorado. He has taught investing and finance at universities and written for Money magazine, the Wall Street Journal and others. His contributions aren't meant to convey specific investment advice.