Amid the global Covid-19 pandemic that is ravaging populations and economies worldwide, investors are questioning what to do with their savings and investment.
The World Bank predicts that the Gross Domestic Product (GDP) for developed countries will shrink 7% from 2019 levels while emerging economics will contract 2.5%.
The Organization for Economic Cooperation and Development (OECD) predicts slightly greater GDP declines, especially if the world experiences a second wave of the coronavirus.
The U.S. Congressional Budget Office predicts that the economy will take until 2029 to recover to previous growth levels.
Michelle Meyer, the chief U.S. economist at BofA Merrill Lynch, agrees,
It’s going to take a long time to heal. There will be scars as a result of such a painful shock of the economy.
Predictions of Coming Economic Disasters
Finding good news about the economy is difficult. Global production is down, unemployment is up, and people are dying in scores around the world.
Even more discouraging is that some prognosticators predict worse times. The analysts at the Deutsch Bank, for example, predict that there is a one-in-three chance that during the world will experience another pandemic killing two million people, global volcanic eruptions, a major solar flare, or a global war in the coming decade. Stretching the time frame to two decades, the odds of a disaster increase to better than even (56%).
The barrage of bad news triggers investors’ fears of lost or severely reduced savings in the coming months and years. Even the sanguine anxiously watch press reports and the track the daily changes in their portfolio values:
Is this the beginning of another “Great Depression,” the period between September 6, 1929 and June 27, 1932 when the S&P 500 lost more than 85% of its value? GDP fell by more than 30%, and unemployment in the U.S. exceeded 20%. Many of the stock prices of the companies in the Index took years to recover their 1929 levels – an average of twelve years.
The Stock Market’s Direction
Investors with money in the market ask, “Should I sell my assets and retreat to an imaginary bunker until the carnage is over?” Those who are just starting an investment program are wondering if they should delay their plans. Given the dire economic forecasts, expectations that the stock market will severely retract are common:
- “The coronavirus-induced bear market [would be] the shortest bear market on record—if it were indeed really over. The reality is more complicated.” Fortune magazine, March 27, 2020.
- “My best guess is that U.S. stock prices will pull back in coming months, but the March 23 lows will hold. .. But I’m prepared to be wrong — again.” Mark Hulbert, MarketWatch, May 30, 2020.
- “Today, we are in a recessionary environment, and the contrarian indicator may weight even more. The technical picture is not different. All boxes for bear market rallies are ticked, and equities are ready to roll over. The market needs some catalyst to sell-off. It will probably drift more or less sideways until that happens.” Source: ESI Limited. Seeking Alpha, May 24, 2020 (https://seekingalpha.com/article/4349820-prepare-for-bear-market).
- “… all the classic traits of a classic bear market rally have surfaced, and it’s getting to the stage where investors simply cannot ignore the warnings signs anymore.“ Traders Magazine, June 8, 2020.
- “If historical patterns repeat, then stock investors will continue to experience a rough ride accentuated by swings in sentiment, as earnings decline sharply and rebound, and market sentiment moves from excessive optimism to excessive pessimism and back again.” Hersh Shefrin, Forbes Magazine, April 12, 2020.
Many observers liken the current economy to the global economies of the 1930s, the period the world called the Great Depression. Then, as now, investment experts were publicly predicting how the stock markets would react in the environment.
During today’s confusion about the market, it is helpful to look to the past and learn whether the prognosticators then correctly predicted the future market.
Alfred Cowles III, an American economist and businessman, did a study in 1932, followed by a second one in 1944. He found that a random guess was better than most expert opinions at the time.
Trying to pick the tops and bottoms of stock market trends, even their direction, is virtually impossible. As yet, no one has proved to be accurate over any significant period, despite years of experience and education.
The likelihood that a beginning investor can accomplish what millions before having failed is the height of hutzpah. A better approach is that espoused by Dan Caplinger of The Motley Fool:
For long-term investors, the entire premise of using short-term market timing to try to wait for the absolute bottom in the stock market before buying stocks is flawed. If you have cash to invest at this point, you’re already getting a huge bargain compared to where prices were as recently as January and early February.
A Safe Approach to Long-Term Wealth
Investing should be considered a long-term strategy to reduce the risk of stock market fluctuations created by human emotions, especially fear of loss.
Warren Buffett, one of the most successful stock investors of all time, has stated, “If you aren’t thinking about owning a stock for ten years, don’t even think about owning it for ten minutes.” Few successful investors would disagree.
Those who want financial independence the sure way without times of gut-wrenching anxiety over their investments should pursue a long-term strategy and practice four main investing principles:
- Principal compounding. Building significant net worth is all about persistence and consistency over the years. Regular contributions to an investment account enable a compounding effect – money earns money, just like hiring an employee to work for you. Investing $100 per month for ten years – $12,000 investment – at the S&P 500’s average return for the last ten years (11.174% from June 2010 to June 2020) in income tax-deferred plan accumulates $22,224. Continuing the plan for an additional ten years ($24,000 total investment) grows the fund balance to $89.507.
- Dollar-cost averaging (DCA). Investing the same amount of funds on a regular periodic basis smooths out market volatility and eliminates the temptation to call market direction. Buying fewer shares at high prices and more shares at lower prices ensures an investor pays a price per share between the highest and lowest price for the period. This practice eliminates the possibility that your cost basis will be at the top of the market. Employing a similar strategy when selling – selling the same number of shares on a regular periodic basis protects an investor from selling at the low price of the market.
- Diversification. Risk is always present when investing or savings. Burying your money in the ground incurs the risk that someone might discover and steal it. There are no guarantees in the stock market. One-time blue-chip companies like Sears and J.P. Penny are on the brink of disappearing, the global airline industry is on its knees seeking government assistance, and crude oil prices in March 2020 were only slightly above the price in February 1947. An S&P 500 index fund reflects the price movements of the shares of America’s largest and most dynamic companies. While some will suffer from the effects of the pandemic, others will prosper. An investment in the S&P 500 is not an investment in one or ten single companies, but an investment in the ingenuity and strength of the American economy.
- Minimal leverage. The Greek Archimedes supposedly said, “Give me a lever long enough and a fulcrum on which to place it, and I shall move the world.” Credit is the lever of financial investments. Brokerage houses and banks are willing and eager to loan funds to buy and sell securities for the cost of interest. Depending upon the environment, an investor can borrow one-half of most stocks’ purchase price, hopefully repaying the loan with sale proceeds. If the stock price is higher at sale then its purchase price, leverage – borrowing money to buy shares – increases the financial return. Unfortunately, if the sales price is lower than the purchase price, the same leverage increases the loss. Borrowing money to buy securities increase risk and the ulcer factor of stock ownership.
This Time is Different
The economic news and analysts who prophesy a financial melt-down in the global stock markets might persuade some that this bear market is unlike any experienced previously. Consequently, they might defer beginning an investment program. A review of the S&P 500 history is enlightening:
During the past 100 years, there have three periods an investor who inadvertently began an investment program at a high had to wait months, even years, before the index returned to its value at the start of the period:
- Period 1. On August 1, 1929, the S&P closed at 31.71. On May 1, 1954, the index closed at 32.31. Investor A made a one-time $15,100 purchase – the equivalent of 476.2 units – that August 1929. Almost 25 years later, his units were worth $15,386, a gain of $286. However, Investor B followed the DCA strategy and invested $50 each month for the same period and the same investment amount. The value of his account on May 1, 1954. was $37,402, with a compound average growth rate of 9%.
- Period 2. On November 1, 1968, the S&P closed at 108.37. On August 1, 1972, the index closed at 111.09. Investor A made a one-time $2,300 purchase – the equivalent of 21.2 units – that November 1968. Almost four years later, his units were worth $2,343, a gain of $43. However, Investor B, following the DCA strategy and invested $50 each month for the same period and the same investment amount ($2300). The value of his account on May 1, 1954, was $2,684, with a compound average growth rate of 20%.
- Period 3. On August 1, 2000, the S&P closed at 1517.68. On the index closed at 1569.19. For a few days in 2007, the index hit its previous high before quickly falling again and finally closing on March 1, 2013, at 1569.19. Investor A made a one-time $7600 purchase – the equivalent of 5 units – that August 2000. Twelve years and eight months later, his units were worth $7,846, a gain of $246. However, Investor B began his DCA strategy on August 1, 2000, and invested $50 each month thereafter. By March 1. 2013, he had invested $7600, but his investment was valued at the same investment amount. The value of his account on May 1, 1954, was $10,380, with a compound average growth rate of 5.7%.
Is this time different? History says, “No!”
In each case above, even though Investor B started an investment program at the top of the market up until that time, they were better off financially than if they had not begun a regular investment program, earning as much or more than other investment types.
Celebrity financial adviser Suze Orman, during a May 2020 interview on CNN, advised listeners, “I can guarantee you that if you stay in and you just stick with it, three years from now you will be very, very happy that you did.”
She also recommended, “You should be dollar-cost averaging every single month into the stock market.” Unlike Ormon, I will not attempt to call the direction of the market, but I agree the dollar cost averaging is sound advice for everyone with the added recommendation: Invest in Index Funds.