Should I get out of the stock market?
Is it time to cut and run?
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There are no two ways about it — 2020 has sucked. When the year started, the economy was booming and unemployment was low. Wages weren’t necessarily rising, but the stock market was at all-time highs, and things were generally humming along.
Boy, those were the days.
After hitting all-time highs in February (the S&P 500 Index was around 3,400), the stock market fell by more than 30% in just five weeks between February and March.
This correction and the resulting turmoil have left millions of investors with questions. Uncertainty abounds. In May, I found myself sharing recession-proof investing tips, but many are still pondering the same question you are: Should I stick around and ride it out?
The state of the market today
Before delving into the question of whether to stay invested in stocks, it’s worth looking at the last 12 to 24 months in greater detail.
At the beginning of 2020, the U.S. unemployment rate was under 4% (granted, this doesn’t include underemployed people or those who had left the workforce). And, the economy was growing. In the fourth quarter of 2019, the economy grew at a steady but not stellar rate of 2.5%.
Bottom line: In January 2019 both the stock market and the economy were looking phenomenally good.
And then, the (listen-to-the-scientists-and-wear-your-mask-already) pandemic came to our shores.
Within weeks, unemployment in the United States spiked from under 4% to over 14%. GDP contracted by 5% in the first quarter alone—and another 31% in Q2. (Yeah, you read that right. Thirty. One. Percent.)
Of course, GDP recovered by an astounding 33% in Q3, and the unemployment rate is already back under 8%. But that was a wild ride. For many investors, it reminded them of what “risk” actually means when it comes to the markets, and of the terrible financial impacts of black swan events and seemingly 100-year floods (that are more like 5 to 7 years because we’ve quit listening to scientists, again, and decided wildfires are just “redevelopment opportunities”).
So, we’ve seen some signs of improvement—or at least less disaster. But, we still have a ways to go to get the unemployment rate back down and get the economy back to its previous level of OK.
As for the market, while the stock market was at all-time highs before COVID-19, in actuality it was probably too high. At the beginning of the year, the S&P 500’s price to earnings ratio was over 25—nearly double what has historically been considered normal.
And, since the market’s bottom in March, stocks have largely rallied and many have already resumed previous highs.
So, after all of this volatility and with so much uncertainty looking ahead to 2021, what if you’re worried you might get hit by another big correction?
How can I protect myself?
One thing’s for certain: Whether you decide to exit the market right now, it’s worth starting to prepare for the next market downturn. Because rest assured, it will come — probably sooner than any of us would like. Now is the time to reassess your risk tolerance and reconsider both your short- and long-term financial goals.
Based on your findings, you might:
Get out of the stock market
You may decide that this ride has just been too much for you, and you’d rather not stick around for the next one. Personally, I’m encouraging friends and family NOT to go that route (for reasons I’ll explain later), but that doesn’t mean that it’s not right for you.
If you’re thinking about getting out of the market, consider whether you’re willing to forgo gains in exchange for peace of mind. The author of this article, for example, has missed out on 14% gains since he decided to get out due to market uncertainty, but he may also have slept much more soundly at night.
Instead of getting out of the stock market completely, think instead about spreading your money around a little bit more. That way, you don’t get hit as hard by movements in any one investment.
(Of course, while you may not get hurt as badly if one of your investments declines, this also means that you won’t make as much if one of them increases in value.)
Under this strategy, if you own mostly stocks, you might consider buying some bonds or investing in a bond fund. If you’ve invested mostly in companies in just a few industries, think about investing in other sectors. This article lists a few resilient industries that are more likely to withstand unpredictable economic factors and market volatility.
The whole goal is to spread your investments across many options so that losses in any one of them won’t hurt as much.
Sock away cash
If you aren’t sure what direction the market is going to head in over the next year or two, you might think about just leaving your investments as they are, but holding off on any new contributions. Instead, you can just start accumulating cash in a savings or money market account, or short-term CDs.
While this step leaves you exposed to future fluctuations in stock prices, it also gives you a great degree of flexibility later. If stock prices continue higher, you can still participate in the gains. Or, if stock prices decline, you can decide whether you want to take advantage of buying opportunities by investing more.
Alternatively, you might decide to buy something that isn’t tied to the stock market, like a rental property.
In the financial industry, this is often called “keeping some dry powder.” What you’re really doing is setting aside cash to have at the ready in case you decide to “pull the trigger” and buy something later.
Buy big names
As with so many other things, when it comes to investing there’s often strength in numbers. If you want to stay invested in the stock market but are worried that there’s more volatility coming, you might consider focusing your investments in stocks of large, established companies.
These blue-chip stocks are often safer because so many investors own them, as do mutual funds, which aren’t typically subject to panicked selling.
In other words, stocks of large companies are often more stable simply because the companies are larger and more people are invested.
If this logic seems unsound, you aren’t entirely wrong — you’re just forgetting that the stock market has more to do with people’s feelings than the economy.
How to react when the market sours
If we know one thing, it’s that the volatility that stock prices experienced in 2020 isn’t the last time that stocks will be thrown for a loop. The nature of stock investing is that you have to be willing to stick through not only the good times but also the bad. So, when it comes to finding your way through, just remember that there are generally three options:
1. Buy the dip
One of the most popular—and the most profitable—ways to react to a drop in stock prices is to buy more.
Investors who decide to take advantage of near-term buying opportunities are discouraged from trying to time the market. Instead, spread out new investments; add to positions incrementally.
A lot of people who try this strategy focus on the goal to buy before stock prices go back up, but focusing on that timing element can be dangerous. Often, this leads people to watch stock prices too closely and wait for just the right time to invest in a falling stock. In industry-speak, this is called trying to catch a falling knife—as much due to the typical results as the psychological process.
And, of course, this whole strategy presumes that investors are buying shares in companies that will survive whatever volatility they’re encountering. While this is normally the case if you’re buying shares in big, established companies, if you’re trading penny stocks, you may be in for a rougher ride.
The process of investing incrementally in the same investments over long periods of time, regardless of price, is often referred to as dollar-cost averaging, and it’s definitely worth studying more if you’re just getting started investing.
2. Sit tight
Taking advantage of dips in stock prices by buying more can make all the sense in the world. But some people just struggle with going against the crowd by buying when it seems like everyone else is selling. If you can’t bring yourself to buy, you may elect not to do anything—don’t buy, don’t sell, just sit tight.
If anything, you might decide to review your portfolio to see if there are any investments you’d like to reallocate.
But, for the most part, this is very much a calm, measured, wait-and-see approach. And there’s nothing wrong with that.
The last way you can generally react to market volatility is to panic and run for the exits — to sell everything and move to cash. This is the option that we rarely recommend.
Because by the time most investors think it’s time to sell, it’s usually too late. And, by the time they get out, they’re usually just setting themselves up to miss out on gains as the market recovers, rather than avoid any additional losses.
So, in truth, running for the exits is usually counterproductive. Go figure.
But, whether you decide to stay in the market or get out, it’s important not to make the decision emotionally. Instead, if you decide to get out of stocks, do so only after calmly and objectively weighing your options.
And, be sure you have a plan for when and how to get out and what to do with your money after you sell. Are you going to put your cash in a money market account? CDs? Treasuries? Whatever it is, know the plan and the why.
So, what to do now? Should you get out of the stock market or not?
As with so many other things, you have to decide what’s right for you.
For my part, I’m not getting out. I’m plowing more money into investments through my company’s 401(k) than ever before. But, that’s at least partly because I have a great employer match at work and have spent the past three years paying off debt—so I don’t need all the cash from my paycheck.
And, I already have a small portfolio of rental properties (which I also intend to grow, don’t get me wrong).
I gave up a long time ago on trying to time the market. I don’t do much selling. Instead, I focus on buying, and my criteria for picking investments is pretty simple: I just ask myself whether I think the price of a particular investment will be higher in 10, 20, or 30 years when I’m going to need the money.
If the answer is yes or a resounding “who knows,” then I keep buying.
If the answer is no, I don’t buy. If I already own shares, I don’t necessarily sell; I just don’t buy more. Instead, I put money towards a down payment on another rental property—or just sock away cash until my answer changes.
The opinions expressed in this article are for general information purposes only and are not intended to provide specific advice or recommendations about any investment product or security. This information is provided strictly as a means of education regarding the financial industry.