What investment lessons can you take from the covid-19 market decline?

I’ve been getting these questions a lot:

What is your opinion about the recent market decline? Are you adapting your strategy to the new market reality? Are you investing in specific stocks or sector ETFs that are cheap? Are you buying the market dip?  Is this the right moment to invest?

My answer is: Nothing changed about my investment strategy. I will explain why in this post.

We are likely experiencing just the start of the economic slowdown caused by the novel coronavirus, covid-19.  

This may be the first severe market decline for many of the readers of this blog. You may have read about significant market declines. Now you are going to live through it.

This event is an opportunity to remember some timeless investment lessons. Try to learn as much as you can from this experience.

Stocks are down, and bonds are up

Stocks and bonds are not perfectly correlated. They experience gains and losses in different periods.

The Vanguard FTSE All-World ETF has had massive losses, as you can see from the “returns in periods (USD)” graph below.

Returns in periods (USD) Source justETF

Note that the losses reported are for a one-off investment in different points in time. If you are investing periodically, your losses are considerably lower because you would be buying shares at different price points.

Bonds have behaved differently. The Xtrackers Global Sovereign ETF has seen moderate positive returns despite the negative yields in some Eurozone government bonds.

Returns in periods (EUR) Source justETF

Investments do not grow constantly

According to Credit Suisse’s Global Investment Returns Yearbook 2019, an investment in world equities grew at an average yearly real (i.e., after inflation) return rate of around 5% for the period 1900-2018.

Although we like to talk in averages, it does not mean that investments are always growing. They don’t grow like shown in the image below:

In reality, investments go through booms and busts, they rise, and they fall. Below is a chart from Backtest of the growth of €10,000 using the Vanguard FTSE All-World ETF. Notice the significant decline in 2020.

Growth of €10k, Source: Backtest

Long-term investing requires enduring serious market declines. During the great financial crisis, the portfolio from the graph above declined by 47.9%, and it took five years and three months (!) for it to recover to the previous peak.

Severe market declines are why you should invest for an extended period. If you invest for a short period, you are likely to lose your money during a severe market decline.

Market declines are expected. This may be your first. But it won’t be your last one. There is no way around it.

Should you invest in specific companies (e.g., pharmaceutical companies) or sector ETFs that are cheap?

No. The majority of regular investors that buy specific stocks lose money. Heck, even professional investors have a hard time beating the market.

I am an index investor because I want to avoid making active bets on the market. This didn’t change when the pandemic started.

I believe the market as a whole will eventually recover and rise. It may take a while, but this too shall pass.

I don’t know which specific part of the market will drive those gains. So I will keep buying the whole market, through an index fund/ETF.

Is this a good time to be investing?

think so. It is impossible to know in advance when it is the perfect time to invest. I can’t predict the future, sorry!

Research shows that it is almost impossible to consistently succeed in trying to find the perfect time to invest. Don’t even bother trying!

Would you have predicted six months ago that a global pandemic would cause a global market’s slowdown?

However, there is one thing you can do. Keep investing. Investing regularly will ensure you don’t miss periods of continued compound growth. These periods are essential for your portfolio to grow.

Severe market declines are great for folks at the beginning of their investment journey. It means they can buy shares at significantly lower prices. Remember: “buy low, sell high.”

If you are afraid of starting your journey now with a large investment amount, you can spread it over a couple of months. That may not lead to the highest returns, but it is okay if it is what you need to start.

On the flip side, these market declines are terrible for folks who are retired and withdrawing from their portfolio. This is called the “sequence of returns” risk. You may have to adjust your exposure to less risky assets depending on where you are on your journey.

Staying the course is challenging

We like to obsess about:

  • the ETFs for the perfect portfolio;
  • the best broker;
  • how much to allocate between the developed world and emerging markets.

Honestly, those are the most straightforward choices you will ever make about investing. That is just the tip of the iceberg.

The hard part is to stay the course. “Keep investing” is easier said than done. When the market conditions change, many suddenly start wondering whether investing is a good idea or which cheap stocks to pick. We tend to do the things we are supposed not to do.

Investing is a marathon, not a sprint. Managing your psychology is hard. You will succeed in investing if you avoid making bad decisions in bad times. Or, as Nick Maggiulli would say: Avoid the Zeros.

I like to regularly remind myself of this post from Taylor Larimore in the Bogleheads forum:

Figures cannot convey the horrifying and debilitating effects of a bear market.
You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money.
Your friends and relatives urge you to sell. Nearly all financial experts recommend “sell”.You are ridiculed for trying to hold on. You begin to have self-doubt. Despair sets in. Buying stocks is unthinkable. Suicides increase.
That’s what a bear market is like.

I don’t think we are at a severe recession yet, though. I still see many considering buying the dip. When it gets serious, few do.

It is crucial to take measures to help you stay the course despite a severe market decline:

  • Have an emergency fund – This will help you avoid selling your equities if you get unemployed. It will also give you some peace of mind.
  • Pick an appropriate equity/fixed income split – If you can’t stand the idea of having your whole portfolio worth 50% of its original value for five years then, please don’t put all your savings into stocks. You can place the remaining amount in a savings account or bonds. 
  • Keep yourself sane – Reduce news consumption to a minimum. Don’t check your investment account balance every 5 minutes. Get some exercise. Stay healthy.

Why has nothing changed in my investment strategy?

My investment strategy relies on focusing on the things I control. And ignoring things I don’t control.

I control:

  • How much I invest (and for how long) – I invest monthly after I draft my budget. My lifestyle is not as frugal as Mr. Money Mustache’s, but I try to have a high savings rate. I am planning to invest for a long time.
  • The types of assets I invest in – Low-cost, diversified index funds, and some corporate pension plans.
  • How I apply my human capital – I am at least 30+ years away from retirement. Until then, I will learn and apply skills that will increase my income. This, in turn, will allow me to invest more. “You may say I am dreamer, but I’m not the only one”.
  • My emergency fund – I hold enough cash so I can sleep at night.
  • How much news I read – I read zero financial news. I find them overly sensational and detrimental to my mental health. I have no interest in knowing how much the markets changed on any given day – that can only encourage daily trading. I do read many financial blogs and books. But mostly to learn timeless investing lessons. I only look at my investment account balance once a month: when I invest more.

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Do also note that I am fortunate enough to be privileged. I can work from home so, the pandemic won’t affect my ability to earn an income. I have a stable job. I also work with technology on a field with plenty of demand for skilled professionals. My risk profile may be different than yours. You can’t extrapolate my risk assessment to the risk assessment of an hourly paid employee at a bar that just got closed for a month.

This is why investing is highly personal, and you have to understand your risk profile. And why most of my writing focuses on explaining the principles of investing. Instead of just telling you how I invest. How I do things may not be relevant for you because you have a different situation. But if you understand the principles, you can adapt them to your situation.
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I don’t control:

  • How much the market will fall
  • When will the market fall
  • How much the market will rise
  • Which portfolio will bring the highest returns
  • Which portfolio is best suited to weather all scenarios

I firmly believe that what I control is all I need to succeed. It is a leap of faith, though. I have faith in the countless research I’ve read that proves this.

I am also not attempting to buy the dip. I invest monthly so, if I had purchased the dip, I would have invested roughly 1/12 (i.e., ~8%) of my yearly investment amount. It is not a significant amount of money in the grand scheme of things. Especially given, I will do this for three decades.

It can wait. I am always a few weeks away from the next investment. Severe market declines last for a long time, so I will have plenty of opportunities to buy shares at low prices.

Also, buying the dip requires paying more attention to price movements (and market news) than what I am willing to do.

What can you do now?

I think the most useful thing you can do now is to learn. Learn how you react. Learn about what has happened in the past. Learn if your plan still makes sense.

Ben Carlson wrote a useful set of questions you can try to answer. I would add the following ones:

  • Are you comfortable with the percentage of equities you have in your portfolio? If you are not, consider increasing your allocation to cash/bonds.
  • Are you comfortable with the size of your emergency fund? If not, increase it.
  • Are you uneasy and scared about the current environment? Note it down. Learn how you react in these circumstances and adjust accordingly

Above everything, avoid taking hasty decisions:

  • Take your time to think;
  • Write it down;
  • Get a second opinion.

The book “If You can” is one of my favorite investment books. It packs so much knowledge in so few pages. On it, the author argues that the most important word in the book is the word “if”. The passive investment recipe is simple, if (and that is a big if) you can implement it.

Market declines like this are what makes investing challenging. You can weather them with proper preparation.

I hope your family is healthy and safe in this difficult time. Let’s work together on “flattening the curve”.