The S&P 500 posted a correction (10% drop from an index’s peak) since the Great Depression as fears of a recession caused by corona virus are incorporated in the price of securities in markets all around the world. The six days of consecutive declines have established the the fastest correction since July 1933, when the S&P 500 plummeted 13.3% in two days, The Financial Times reported.
First of all, let’s not talk about the risks of the virus itself. There is a lot of information about that all over the internet and mainly that topic is not really my cup of a tea. WHO published some basic protective measures so let’s follow those and leave the discussions about the origin and cure for the virus to the experts in the field.
From the investor’s perspective the most important issue is the impact of this market correction. Steep decline pushed investors to switch out of equities into defensive assets. Treasury yields hit several record-lows and precious metals gained before the stock slump.
When we’re talking about investors’ fears, we’re not talking about the virus itself, but about the impact on the international business and about worries that measures the governments will have to introduce will impact the production output, traveling and consumer spending. Ceased production in one factory due to safety measures can impact not only one corporation, but all the other ones which are dependent on output from that factory as well. There is a significant risk that important international economies can slide into a recession and this will bring down all the other players as well. So when you’re considering only mortality rate of the virus and it seems that all of this is just a huge overreaction, you might not take into account other important aspects as well.
My Stocks Are Crushed. What Now?
The most important question for an investor is what to do at the moment. Whatever you feel is the right choice, always remember not to panic. To sell everything you own means to realize all the unrealized losses. It might be the greatest decision if the current sell-off continues but can you really predict the market? We’ve all heard the old saying “time in the market is more important than timing the market.” Lot of different studies and experience of largest portfolio managers shows that market timing doesn’t work for general investors’ community. But everybody needs to find that out for themselves.
One has to realize that external shocks can derail economic trends and abruptly alter market sentiment. Not all recessions were caused by governments and central banks. And this one might be the example of that. It all comes down to the virus itself. Will it become the world’s deadliest one of all times? Because the history shows that the market didn’t react like this yet. Are investors’ onto something now or is it just an exaggeration? If I would know the answer, I would be now all in the market…or all out.
What To Do With Alternative Investments?
Most of my alternative investments consist of of some form of debt financing. Thus, another important question emerges – Should I be worried if the recession comes?
Crowdlending or crowdfunding is a relatively new form of financing in current scale. It always existed in some form, but nowadays the volume is so huge that we need to dedicate a separate chapter in this article. The problem is, however, no one knows any lessons from the history, how crowdfunding reacted during market turmoils. Simply because it never went through any such event.
Let’s put aside crowdfunding for equities, where the reaction should be similar as the stock market for small caps with much lower liquidity. Crowdlending as the term used for crowdfunding for loans in theory should react similarly to fixed income instruments such as bonds. But as the market is unregulated and liquidity is questionable, it all comes down to individual retail investors who will now compete with limited knowledge in the area which is not overseen by any regulator. To be honest, I’m a little worried what might happen here. During the regular crisis, I can imagine that we will see the restrictions imposed to secondary markets as the investors will not be able to price their share correctly and the buyers will have only limited knowledge about the offers. If you don’t feel comfortable that liquidity might be restricted a lot during the regular recession, act accordingly beforehand.
Other than that, keep in mind that if you invested in some construction or other new projects, those might in the end not be undertaken because the risk of the project changes and it turns out it’s not profitable anymore. If you invested in other real estate backed projects, keep in mind that the value of collateral might get lower than your investments. If you invested in loan originators’ business, they might get crushed because of more and more personal bankruptcies and problems with debt collection. But this is just a theory and what’s more important, we don’t have a recession yet. It’s still only one of the possibilities.
Buy High, Sell Low…Or How Was It?
When the market is peaking, you can see the commercials encouraging you to invest everywhere. Funny that when the market drops, marketing is suddenly not that visible. But this is exactly the reason why a lot of retail investors buy and sell stocks at the wrong time. As already said, I’m not the fan of timing the market. Dollar cost averaging is for me the most efficient method for retail investors there is. Buy every month, continuously. If the market drops, don’t sell and buy the same as in prior months or even a little bit more. I’m here for a long-term and hopefully corona virus will be sticking around only for a while.
I did a little simulation on American index S&P 500 which monitors the stock performance of 500 large companies listed on stock exchanges in the United States. In my simulation I compared initial investment of USD 24,000 done as of 1.1.2000 and monthly investment of USD 100 done at the beginning of each month till the end of 2019. I decided to ignore dividends and transaction fees for simplicity.
The difference as of 31.12.2019 is around USD 3,000 in favor of dollar cost averaging. But this outcome is actually much more more significant due to time value of money. There is a huge difference to invest USD 24,000 in the 2000’s compared to monthly investment of 100 bucks because if you invest only 100, you can invest the rest of available cash to some other projects and then decrease the balance of other investment continuously to make your monthly investment in S&P 500. Let’s say you would invest spare cash to low yield government bonds with return of 2%. Guest how much more you would earn from those. Additional USD 6 thousands. In total, you’re better off by 10 thousands. No bad, huh?
What’s even more interesting is that by using the dollar cost averaging method, your profit would be higher in almost every point in time. Dotcom bubble would not impact you that much because you invested only a small chunk of money till that point. And after the collapse of the markets, you continued to invest when the prices were low. All in method would break-even only before the next financial crisis and after a few months if would be in red numbers again. On the contrary, there are only few months in the whole period where you’re in red numbers under dollar averaging method.
You can definitely find examples where all in strategy ends up better. For sure. But that’s not the point. Using dollar cost averaging means admitting that you simply don’t know what might happen to the market. And instead of that, you focus on diversifying the risk of purchasing in the wrong period by purchasing in every single period possible. Simple as that.
If you want to bet that the market is going lower than it is now, feel free to sell. But when you do, you change your strategy from investing into speculating. I tried to speculate during my university studies where I tried to find the sure opportunities. It turned out that they weren’t that sure as I thought and together with leverage used, it didn’t go well. I lost a lot and after that, I decided that it is not the right path for me. It doesn’t necessarily mean it is not right for you though. But statistics show that even if you would be successful couple of times in timing the market, it might be just a coincidence rather than skill.
My strategy is to slowly buy more stocks in the form of ETFs and individual stock picks once, two times a month or right after any other significant dips. I don’t plan to buy any other securities (except for filling up the savings account to pile up a cash a little) in upcoming periods until the situation with corona virus and its impacts on the international markets will be much clearer. It might happen that not all cash will be invested and I’m fine with that. As this is the first important test for my portfolio, I don’t want to make any stupid mistakes.
Anyway, good luck to you. Times like these really separate winners and losers in the financial world. Remember that at the end of every transaction, there is an opposite side. Are you the one making the smart decision of buying or is the counter-party the smarter one when selling? Hopefully, we’ll be on more successful side in the end. Now let’s wash our hands and invest 🙂