Here are some questions I get every day (sometimes every hour!) and my answers.
Q. How much worse could it get?
A. No one knows. Really. A lot of pundits like to get on TV and give their predictions. You should ignore them. It is much easier to take appropriate action once you accept the fact that no one knows.
In theory, it could get much worse.
One respected advisor noted that if price earnings ratios fall to the levels of previous bear markets, they could reach as low as 6, which would be a substantial drop from the current level of 13. This drop in P/E ratios would have a substantial adverse impact on the markets.
Q. How long will it last?
A. Again, no one knows.
Japan is still waiting for a recovery of the Nikkei to the dizzying heights it reached in 1990.
Trying to time the market and figure out when it will recover is a fool's errand. The Wall Street Journal reported
on the results of a study by SEI Investments. The study looked at twelve bear markets and concluded that those who held on to stocks when the market bottomed out profited handsomely from their restraint. Investors who bought back into the market only 3 months after the bottom lost more than 50% of the profits gained by those who did not try to time the recovery.
Q. What should you do now?
You certainly should not rely on anyone who claims they know the answers to the first two questions.
You should check your asset allocation. If it is no longer appropriate, change your holdings so that your portfolio has the right risk level for your current investment objectives and tolerance for risk.
If you have the right asset allocation, consider this data (which is not predictive of future returns): In the last 50 years, a globally diversified portfolio of stocks had positive returns in more than 97% of any 5 year period and in 100% of any ten year period.
You hold stocks for the long term. If you don't have at least a 5 year time horizon, you should not be exposed to any stock market risk.
While this advice is easy to give, it can be difficult to follow in bear markets like the one we are experiencing. Behavioral finance experts have identified a series of traits that may govern your conduct, without your being aware that you are not entirely in control of your actions.
Men especially tend to be very overconfident in their stock market abilities. This well-documented trait may cause them to be sure that they are right in making investment decisions contrary to well-established data.
Investors tend to extrapolate results from recent experiences. The current media drumbeat about recessions and even a depression has caused many investors to ignore the long term results of the stock markets and to overreact to the current market crises.
Closely allied with placing too much emphasis on recent events is stubbornly holding to beliefs, even if the evidence is to the contrary. For example, investors who believe we are headed for a depression are unlikely to be persuaded by even the most compelling evidence to the contrary.
Finally, investors tend to be more affected by losses than by gains. The strong desire to avoid losses may cause these investors to act precipitously because of their desire to "stop the pain" of continued market losses.
These and other behavioral traits may well be the reason why so many investors panic, sell low and buy high.
Investors are understandably concerned about the markets. Bailing may be appropriate for some. Staying the course may be the right decision for others.
Whichever decision you make should be based on hard data and an objective review of the risk of your current portfolio. It should not be influenced by talking heads (whose predictive powers are no greater than yours) or by behavioral traits that may be subtly influencing you to act against your best financial interest.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.