Normally, you don’t think about your retirement investments in terms of a one-year time horizon. But we are not in normal times, and many investors feel a great deal of anxiety about what’s going on. Some are concerned that if they invest in the stock market and the bottom falls out, they’ll never recover the money. Others see the stock market chugging ahead despite all the terrible economic numbers and wonder if they are missing out.
In our current environment, it seems like the markets teeter on the edge of boom and bust every day. The good news is that it’s not usually like this. At some point, we’ll have more clarity about the future and markets will settle down. But for the next year or two, we could be living in this tug of war between hope for a recovery vs. reality about the virus and its impact on the economy. So what should you do until we get back to a more normal market?
I think a practical approach is to take a look at the range of probable outcomes and then position your portfolio based on that assessment. From the “I could lose a lot of money” side of things, there is a possibility that public officials cannot get functional control of the virus. If that’s the path we take, then we all have to restrain our activities to stay safe. Under that scenario, economic activity may shrink for an extended cycle and that means the outlook for stocks is probably not good.
But how likely is this? It’s hard to say, but it’s certainly not 100%. It’s probably closer to 50% or less. Why? Right now, we have over 100 versions of a vaccine being worked on and medical professionals are learning how to better treat those with COVID-19. This is reducing hospitalizations and deaths. We also know that wearing masks is a simple and effective way to help contain the virus. Thus, it seems more likely than not that we will be able to keep the virus in check and develop a medical solution within a year or two.
If that’s the case, then you are going to want to have some money in stocks. Because of all the stimulus money flowing into the economy, once people feel free to return to normal, we could have a period of rapid economic activity. Investors will anticipate this and quickly move stock prices up to reflect the more optimistic future.
But what about the possibility that we won’t find a medical solution? That does exist, and it’s a good idea to hedge against that. Now, how do you hedge against something like this? Well, you want to own assets that will hold up in value if the stock market goes down the tubes. There are simple solutions to this with things like FDIC-insured CDs, Treasury bonds, and savings accounts. While boring and offering little to no return, they do offer safety, and that has value today to hedge against the unknown.
In a nutshell, an effective medical solution favors stocks and no medical solution favors cash, CDs or Treasury bonds. But how do you decide how much in each? Again, it’s good to consider the odds here and weight your portfolio based on what you think is more likely to occur.
Let’s say the odds right now are roughly 50/50 that we’ll get a medical solution within a year to 18 months. Then you might want to consider having 50% of your money in diversified stocks and the other 50% in the safer assets. Right now, I think this is a fairly rational approach to the issues we are facing.
But, the odds can change rapidly these days. It’s like being at a blackjack table in a casino. With every card that is dealt, the odds change. For instance, if the first four people at the table are all dealt a face card, the odds are lower that you’ll also get a face card. As reality unfolds, the odds change.
If you want to invest through this cycle and seek competitive returns, I suggest you pay close attention to what’s happening. If you see a pattern of things getting worse, you may want to scale back risk, if getting better, you may want to increase a little. Again, this is not something you’d normally do with retirement assets, but these are not normal times.
The reality is that depending on how things progress with the virus, the market can rapidly move 30% to 50% either way. Basically, we could have years’ or even decades’ worth of returns in several weeks, which can have a big impact on the wealth it has taken you a lifetime to accumulate.
If you read this and think, “I can’t take all the uncertainty, and I can’t sleep at night.” That’s also a perfectly normal reaction to this situation. And if that’s the case, then I’d favor primarily sitting things out for the next year. Consider putting most of your money (70% or more) in safe assets and accept that you may miss out on some big gains, but you’ll at least keep what you’ve got. Then reassess things once we have a solution to the virus.
There really is no right answer here. The key is to proceed with a strategy you can stick with, and that comes down to knowing yourself and your individual goals.
Charlie Farrell is a CEO of Northstar Investment Advisors LLC. This article is for information and education purposes only. Past performance is no guarantee of future returns, and all investing involves the permanent risk of loss. Consult your individual financial adviser for guidance specific to your circumstances.
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