How the crisis will affect asset allocation?
Author: Value Investor
Date of publication: 2020-04-21
When the market goes higher and higher for many years, even with some hiccups, people become complacent and forget that equities are risky investments. Of course, financial advisors would show you one-hundred-year charts that seem to prove their assertion that in the long run (and in some periods a really long run - from a human perspective point of view) stocks are an excellent investment.
The problem with this is that they show you only the stock chart of the United States, which was not devastated by the two world wars and only benefited from them. Another problem is that they do not show you the same chart adjusted for inflation - and this is quite a different story: real returns are a lot less than what you would expect from looking at a steeply ascending stock price over the years. It is true that bonds, and they argue even the property prices, have fared a lot worse over any prolonged period of time compared to equities.
But how this all applies to a personal situation of a specific individual, who is not planning for 100 years, nor, in the vast majority of cases, even for 20 years. He (or she) usually puts his (or her) money into the stock market hoping that in a few years it grows and that would allow him (or her) to buy a house, put kids through the university, retire and live comfortably, whatever.
Yes, we all try to put some money aside for our retirement and this is an excellent thing. But it is not always the first thing on our minds. My point is that by and large our investment horizon is not that long at all.
Now about the topic of asset allocation, which is tied to our investment horizon: the longer the horizon, the more risk we could take (meaning investing in equities versus bonds) hoping that in the long run we will be ahead no matter what happens between now and the end of this long run, whenever it could be. The thing is that too many people who are close to retirement or already retired, have disproportionally large allocation of their wealth in stocks. And until very recently that looked like a very smarty thing. Now, however, with the markets in turmoil, the sliding stock prices make very many investors really nervous, as for too many of us our livelihood depends on these stocks. This nervousness, no doubt, would lead to a massive reallocation of funds from stocks into savings accounts for now and then to other secure investments. The logic is that it is better to have for sure at least a portion of my former wealth than risk everything when I cannot afford to do this, as I do not have a large enough cushion to support my lifestyle and my near plans.
So, this is just food for thought. Things usually get better and better when everything goes well, but they also tend to compound on the way in the opposite direction. So, stay healthy and never put more money into the stock market than you can afford to lose.