A Flight to Safety
This decade is off to a tough start. The Coronavirus is disrupting global trade, travel, markets, and economies. The 2020 U.S. Presidential election will also add to the uncertainty and confusion. With increasing risk, should you buy, sell, or hold your existing investments?
When forecasts are dire, and projections are bleak, selling your stock positions and moving to cash makes sense. It seems prudent to sell your investments and park the money in a bank until the storm passes, and, when it does, you can repurchase your stocks.
Let’s say, for fun, you invested $1 million in the S&P 500 in 2005 - 100% of your assets. After three years, your strategy paid off. Your account at the end of 2007 is worth $1.172 million, a gain of 17.2%!
Here’s where it gets interesting because, we now know, 2008 was a horrible year for the S&P 500. If you decided to hold, you lost 38.3%. Your original investment of $1 million is now worth $747,392, a loss of 25.2%.
With hindsight, you would have sold your investment on December 31, 2007, to lock in your gains. If you sold, you would’ve been a hero, admired for having the foresight and courage to sell after three years of substantial profits. However, it’s unlikely you would’ve moved from cash to stocks in January of 2009 because we were in the midst of the Great Recession. You probably would have waited two or three more years to get back in the market, missing a 40.5% return. If you reinvested in January 2009, you made 23.6% for the year. If you had the conviction to buy the dip in 2008 and 2009, you made even more when stocks recovered.
If you ignored the bear market and held your stocks during the correction of 2008, you made $2.76 million from 2005 to the year-end of 2019, an increase of 227%. Now that your account balance is $2.76 million, what should you do -sell or hold? If you sell, you’ll pay a capital gains tax of 20%, or $455,243 – a significant number. If you hold, you may encounter another stock market correction. A repeat of 2008 would mean a loss of $1.25 million, but still above your original investment of $1 million.
It’s impossible to time the market, but they're a few strategies you can employ to protect your assets. The first is to diversify your holdings to include different asset classes like small companies, international stocks, and bonds. A globally diversified portfolio of mutual funds would have lost 20.3% in 2008, not great, but better than a loss of 38%. True, you give up some upside, but you protect your assets to the downside. A balanced portfolio of 60% stocks, 40% bonds generated an average annual return of 6.5% since 2005. Your $1 million investment grew to $2.48 million.
More stock means more risk, but it also means more reward. Buy and hold investors have been rewarded for their patience, and, hopefully, this time will not be different. If you want to find out the risk exposure in your portfolio, give us a call.
“Go out on a limb. That’s where the fruit is.” — Jimmy Carter
February 3, 2020.
Bill Parrott, CFP®, CKA®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.