Retirees: Are you biting your nails over the extraordinary number of current geopolitical crises?
Welcome to the club. It does seem as though the global economy’s path forward has suddenly become extraordinarily uncertain, and with it retirees’ portfolios and standard of living. From Europe (Brexit in the U.K., “Italexit” in Italy) to North America (tweeted insults about a special place in hell for one of our closest allies) to Asia (the summit with North Korea, commitments to halt military exercises in South Korea that are withdrawn almost as soon as they are made and then recommitted to almost as quickly), a lack of clarity has become the new normal.
Even though we can excuse retirees for their anxiety, that doesn’t mean you should follow your gut instincts in deciding how to react. In fact, retirees more often than not react in just the opposite way from what would be most helpful.
What follows are three general principles that should guide how you should think about, and react to, such crises.
1. It’s the unknown unknowns to which your portfolio is most vulnerable.
Though you might think this principle means you now really have something to keep you awake at night, the broader implication is that there’s nothing you can do about these unknown unknowns. That’s because, by definition, they’re unknown, and therefore impossible to hedge against. By the time something becomes a known unknown—Brexit, Italexit, a trade war, etc., etc.—its impact on the markets will have largely been discounted.
So the real message of this principle is not to worry, since there’s nothing you can do to anticipate unknown unknowns. The investment corollary is that you don’t need to pay attention to the headlines, which will only serve to scare you. You can if you want to, but don’t do so on the theory that it improves your investment performance.
Josh Brown of The Reformed Broker made this point this way: “106,000 or so flights take off and land every single day, almost always without incident. That’s why it’s news when one doesn’t. Market activity is much the same, almost every day represents a day without a crash… And so anything that has even the slightest imprimatur of potentially crash-y activity leads the headlines.”
2. By the time you hear about something, it will be too late to act on it.
This principle follows from the first one.
The reason it holds: The markets are impressively efficient at discounting the known unknowns, and investors invariably overreact. Take the stock market’s reaction to the prospect of Italy withdrawing from the European Economic Union (Italexit), which hit the headlines in late May and immediately spooked the markets. With the perspective of a few more weeks, however, we see that the collective judgment of the stock market is that such a prospect will not be as devastating as investors initially feared.
It’s forever thus, it would seem. The same pattern was exhibited following the surprising result of the United Kingdom referendum in June 2016 to leave the eurozone (Brexit), you may recall: The market’s worst level was turned in immediately after that result took the market by surprise.
This pattern has more than just anecdotal support, by the way. It is based on the stock market’s average reaction to more than four dozen of the most momentous geopolitical crises of the last century, as compiled by Ned Davis Research. The firm found that, almost invariably, investors overreacted.
You can always quibble with the list of crisis events that the firm included in their analysis. But they included all the obvious candidates between 1900-2014, such as the bombing of Pearl Harbor and the assassination of JFK. What they found is summarized in the accompanying chart; on average, the stock market’s lowest level over the 12 months following a crisis comes in the first month.
3. The immediate postcrisis low is a good buying opportunity.
This principle is a corollary of the second. If the market’s worst level over the 12 months following a crisis is often registered sooner rather than later, then the shrewd bet becomes treating any postcrisis panic as a buying opportunity.
I’m not suggesting that retirees start trying their hands at short-term trading. Most of you have a long-term financial plan with relatively fixed allocations to the various asset classes, and by all means you should adhere to that plan. But if you found yourself overweight in a non-equity asset class or classes, and underweight stocks, you definitely could consider using a postcrisis low as the occasion to undertake your rebalancing.
And even if you don’t use a crisis as a buying opportunity, it’s helpful to reframe the situation so that you at least think about it that way. By so doing, you will be training your psyche into viewing geopolitical events as opportunities rather than the occasion to panic. And that’s a good thing.
The bottom line? These three principles remind me, in a roundabout way, of the famous Serenity Prayer from American theologian Reinhold Neibuhr: “God, grant me the serenity to accept the things I cannot change, courage to change the things I can, and wisdom to know the difference.”
Most geopolitical crises fall into the category of things you cannot change or do anything about. But those with courage will see them as opportunities rather than an occasion to panic.
Source : MTV