Megan Gorman, Senior Contributor
Jan. 4, 2021
New Year’s Eve has now passed and we are all looking forward to a rosier 2021. Yet despite the challenges faced in 2020, stock market returns ended up being a bright spot in a dark year for many investors. In fact, per Morningstar, the S&P 500 Index finished with a gain of 18.4% for the year.
But this type of market performance only looks smooth in retrospect. Living it day to day was a challenge for investors. In particular, the dark days of March and April had many investors doubting their overall strategy. The decisions that were made during this brief period of time had a long-term impact on how a portfolio performed through year end.
Interestingly enough, there were actions taken in 2020 that should be applied to portfolio construction going forward. Investors who maximized their investment returns in 2020 were found to have followed three basic strategies, including having the appropriate amount of fixed income in their portfolio, staying invested and continuing to buy throughout the year. While they may have had some uncomfortable moments while navigating the markets, they are reaping their rewards as we move into the new year.
Don’t Count Out Fixed Income
A frequent comment in any investment discussion is that bonds do not seem to provide any real return. In the low yield environment of 2020, investors were often questioning whether it was even worth having them in the portfolio.
But investors are not focusing on the key part of having bonds as an allocation in the portfolio. Bonds are not about getting return as much as they are about cutting volatility so that investors can participate in the equity markets. It is the “sleep at night” allocation of the portfolio. During the intense volatility of March and April, bonds helped mitigate the severe drop in portfolio return.
Further in 2020, investors were rewarded for having fixed income in their portfolio. The Bloomberg Barclays US Aggregate Bond Index was up 7.51% in 2020. These returns were above average and should not be expected on a go-forward basis. But they make the point that investors can never truly guess at how an asset class will perform.
During the crash that happened in late February, investors were faced with a dilemma. Should they sell and wait out the pandemic or stay invested?
Most experienced investors took the latter option, for two main reasons. First, unlike the 2008-2009 economic crisis, the pandemic felt different to them. While the markets would be volatile, it appeared that if a response and ultimately a vaccine was put into place, the underlying fundamentals of the market were still there.
Second, these investors recognized that trying to outthink the market typically does not end well. Even if they had guessed correctly on when to sell, it is re-entering the market that is the trickier decision. Staying invested and riding through the volatility, the hope was that ultimately in the long term the market would return.
It was a calculated decision that paid off. The US markets started to pull out of a bear market on April 7, 2020. The S&P 500 was at 2663.68 on that date. When the S&P 500 closed on December 31, 2020, it was at 3756.07.
Always Be Buying
Further experienced investors also realized another key element of achieving successful market returns is knowing when to buy. After all isn’t the old joke, buy low and sell high?
But as accurate as that mindset is, actually buying during a downturn is psychologically difficult. In a crisis, human instinct is to flee to safety. The idea of investing more money in a market that appears to be crashing can feel foolish. When the S&P 500 dropped 30% and the Russell 2000 dropped 40% respectively, putting fresh cash in seemed nerve wracking to say the least.
Investors really need to focus on their long-term plan. First, having the right fixed income allocation allows the investor to weather the challenges in these markets. Second, what many high-net-worth investors found is that rather than giving into their emotional impulses, it is always better to consistently be buying in the equity markets. A dollar cost average plan can take a lot of the heartache out of making these decisions.
Further, those who put new monies into the market – particularly at the bottom – have been rewarded for their courage with returns in the 60% range. While these are short term returns, it’s evidence that investing when others are running scared can make a difference.
Strategy Is Key
As investors look to 2021 and hope for a better year ahead, they should take these lessons to heart. High net worth investors might feel the pain of volatile markets, but their reactions are often more measured. Take a page from their strategy and focus on staying invested in the right allocation and buying consistently throughout the year.
By Megan Gorman, Senior Contributor
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