The surge in coronavirus cases outside of China has triggered a global sell-off as investors sell riskier assets and seek safety in government bonds, gold and defensive stocks.
Markets may be in the red but investors who panic usually end up worse off. Think about it. Have you ever made an investment decision you came to regret? Perhaps you sold some stock during a bout of market volatility, only to see its stock price rebound shortly after the volatility passed.
As fears around the COVID-19 virus rages on, it is easy to succumb to the emotional and cognitive biases that push us to make less-than-perfect investment decisions. A deeper understanding of our thought processes however, can guide us towards better decision making. Take our mini quiz below to find out the costly mistakes you should avoid when markets slump.
Answer: Option A – Assess the fundamentals of the stock to decide if it should still have a place in your portfolio
Reacting to a sudden market fall is one of the worst investing mistakes you can make. Large drops are part and parcel of investing. When you panic and sell your investments when markets are in the red, you’re essentially “selling low and buying high”. You’ve converted what would have been a paper loss to a permanent loss.
When markets start to recover, you may not be ready to reinvest. As such, you’ve locked in your losses and missed out on the recovery. The SARs outbreak contributed to a slump in global markets but markets recovered once the outbreak was contained. The S&P 500 did indeed drop roughly 10% from the start of 2003 until mid-March. But if you had sold your investments at the market low and stayed out of the market, you would have missed out the more than 26% recovery the index made by the end of 2003.
Instead of panicking, assess whether your investments are still right. Are the fundamentals and growth prospects still strong? These will tell you whether the reason you bought the stock is still valid.
Answer: Option B – Check your asset allocation and comfort level with investment risk
Be careful about reacting out of fear. Moving to bonds may feel like the “safe” choice, but it may not always be in your best interest, especially if retirement is still many decades away. Bonds should always take up a small percentage of your portfolio for diversification and stability, but stocks are ultimately your main driver of growth. When you invest long-term, you’ll realise that on the whole your portfolio tends to go up even if there may be periods of large drops. In fact, if you take any 20-year rolling period, the US stock market has never lost money – the average annual return over a 20-year period stands at about 6.7%.
Rather than a knee-jerk response, take this time to evaluate if your portfolio is at the right risk level. If your portfolio is giving you sleepless nights amid the coronavirus outbreak, your asset allocation may not be suitable for your risk profile. If you’re unsure, take Syfe’s Risk Assessment to find your correct risk profile.
For investors who are comfortable with risk and / or have a longer investing horizon, their portfolio can generally hold more higher-risk assets like stocks. Risk-averse investors may find they feel more comfortable with a portfolio that holds a larger share of lower-risk assets like bonds, as well as income-generating assets like real estate investment trusts (REITs).
The current market dip is a good time to review your asset allocation and craft an investing strategy that will stand the test of time and economic cycles.
Don’t panic but be prepared
The US stock market has continuously demonstrated the depth of its resilience. 20 days after the 9/11 attacks and the Brexit referendum, the S&P 500 had increased 4.9% and 6.4% respectively. With time, the market is likely to bounce back as countries act to contain the virus.
The current market slump could even present an opportunity to buy more assets at a low price. As other investors dump their assets, you can increase your investments in stocks, bonds, exchange traded funds (ETFs), real estate investment trusts (REITs) and more, for far less than you could just a few weeks prior.
Instead of worrying over your portfolio, take this time to check that you’re in the right place financially. Bump up your emergency fund to cover three to six months’ of expenses; review your financial plan; stay invested; don’t panic. Now might also be a good time to have a chat with a financial advisor who can put you on track for a better future.