The speed and severity of the decline in global stocks and the potential for further losses have a lot of people wondering if they should sell now and protect their retirement savings. Canadians who are close to retirement or recently retired are particularly at risk. There is a risk that stocks could fall further. But there is also a risk that selling now means an investor may not recoup their losses when, not if, stocks recover.
Let’s start by summarizing what we know about the current situation, and the historical context. The Toronto Stock Exchange is trading at the same level it was at in March 2006—14 years ago. In the U.S., three of the largest 20 daily percentage changes in the S&P 500’s almost 100-year history have occurred this month. Global stocks, as represented by the MSCI World Index, are down more than 20% year-to-date.
Interestingly, the Chinese stock market—the Shanghai Stock Exchange Composite Index—is down 10% year-to-date, making it one of the best performing stock markets.
According to Invesco, the average bear market since 1957 has lasted just under 12 months, and the average loss has been 34%. In 1929, at the outset of the Great Depression, U.S. stocks took 30 days to fall 20% and enter a bear market. This recent downturn took only 16 days—the fastest bear market in the history of the S&P 500.
Before deciding how to react to the current COVID-19 fuelled situation, it is important to consider the math behind stock market declines. If stocks fall 10% five times, you would think they would be down by 50% (10 x 5). In fact, they would be down 41%, because each subsequent loss is based on a lower starting value. I know that may be of little consolation, but the math gets better.
If you have a balanced portfolio of 60% in stocks and 40%t in bonds—a common, moderate-risk asset allocation—a 30% decline in stocks might decrease your portfolio value by 18%. Once again, that may not be enough to ease your fears.
What about considering what tends to happen after stocks fall 30%? Ben Carlson of Ritholtz Wealth Management wrote a great post about the 12 previous bear markets that have been worse than the current U.S. stock market decline. He notes the average 1-year return from the market’s bottom has been 52%, and even the worst 1-year return has been 8%. We do not know if we are at the bottom yet, of course, but the point is that stocks tend to perform well in the year following a large decline. The average 3-year and 5-year returns have been 89% and 132% respectively.
What this tells us is that even though stocks could be lower a year from now, there is a reasonable likelihood they will be higher in the medium term, and the longer your time horizon, the more likely stocks will be higher (and even much higher).
If you own an individual stock, particularly shares of a small company, it is possible that one company could go bankrupt and its share price could go to zero. If you own a diversified portfolio of individual stocks directly, or indirectly through a pooled fund, mutual fund or exchange-traded fund, keep in mind the stock market itself will not go to zero. Despite any potential criticisms of capitalism, it is good at making money.
This stock market decline may or may not mean you need to reconsider your retirement date, potential spending in retirement, or other factors. But the same could happen if you lost your job, had an unexpected illness, or had to lend money to one of your kids because they were going through a divorce. Retirement planning and financial planning, in general, are fluid exercises that require revisiting and revision.