The stock market, as evidenced by the S&P 500 index, has posted one of the most dramatic downturns in modern history as investors grapple with the near-term and longer-term effects of the Coronavirus. As of the time of this writing, this index is down approximately 28% from its peak in February 2020 and investors are trying to predict how this situation unfolds.
During this present crisis, uncertainty abounds from a financial standpoint. Most have been very surprised of how quickly the virus is spreading and are concerned with the implications it has had on the economy. However, we believe what is most important is how we react moving forward.
We think it is important to review this downturn in a historical context. Looking back in history, investors have expected a return for putting their capital at risk and periodic market downturns are not unusual. In fact, going back to 1926, using a 20% threshold for downturns, there have been eight bear markets (source: Dimensional Fund Advisors). The coronavirus is now the ninth.
Investors’ responses can have a drastic impact on their long-term investing circumstances. Generally, there are two responses to times of crisis. Many sell stocks and move money to cash while waiting for signs of market improvement. The alternate is to “stay the course” and stay committed to their long-term investment plan.
In determining what we believe is the best course of action, we go back to the basics of how financial markets work. Every trading day, millions of investors are digesting new information and trading on their predictions on how financial instruments should be priced. In other words, stock market prices are reflective of where sellers and buyers agree to transact.
Moving to cash from a long-term investment portfolio implies knowledge superior to aggregate market participants. Unfortunately, this approach rarely works on a consistent basis. Instead, historically the markets have been better equipped to price assets, which is why active management typically underperforms market indices.
We believe the superior long-term approach is to stay committed to your investment plan, which is evidenced by the following exhibit showing the performance of a 60% stock/40% bond portfolio after other crises (source: Dimensional Fund Advisors).