How will economic recovery differ from past downturns?
If you look at the 2008 global financial crisis, the origins were very different from today’s COVID-19 crisis, so we should expect the path to recovery to be different as well. The 2008 crisis was due to deregulation in the financial industry that involved loose credit and too much debt in the housing market. The current crisis is the result of a pandemic followed by an orchestrated slowdown to prevent the spread of the virus. We’ve seen a contraction in the economy that we haven’t experienced since the Great Depression, with expectations for the recovery to begin in the third quarter. A couple things need to happen in order to come out of this:
- First, supply for goods and services has to be available to the public, with jobs and businesses opening back up when it’s safe (not operating at full capacity and with social distancing still in place).
- Second, as retail shops and restaurants open, there needs to be a demand for their services. If people are too afraid to go out, demand will suffer.
- Finally, and most important, there needs to be a medical breakthrough. “We hope that by the end of this year and the beginning of next, we have a vaccine—a broadly distributed vaccine that will take fear off the table,” said Greg Davis, Vanguard’s chief investment officer.
For more details, check out Economic downturn may be deep, sharp, and short-lived.
Should I safeguard my assets by moving my investments to cash?
While moving to cash reduces your risk, it’s important to consider these points before taking action:
- You’ll lock in losses if you sell when the market is down and miss out on the market’s best days. For example, from mid-February to March 23, 2020, the Standard & Poor’s 500 Index was down 33.9%. In the subsequent 3 trading days, the S&P 500 saw a 17% return.*
- You’ll have to decide when to return to the market. Ideally, you’d reinvest when the market’s low to take advantage of future growth as the market rebounds—but this is easier said than done.
- You’ll lose purchasing power over time. “You may feel like you’re being safe because you’re preserving your money,” said Maria Bruno, head of Vanguard U.S. Wealth Planning Research. “However, when you think about inflation over time, you’re actually decreasing your purchase power because your portfolio isn’t able to grow with inflation.”
It’s impossible to predict the best time to get out of the market and when to get back in. That’s why we take a long-term view in everything we do. If you’re considering moving to cash out of fear but you don’t need the money now, we recommend holding your diversification, tuning out the short-term noise, and sticking to your long-term goals. For more information, see 3 reasons not to move your portfolio to cash.
I understand the importance of staying the course, but is there a need to rebalance my portfolio during these volatile times?
Market volatility can cause your asset allocation to shift. For example, if you’re heavily invested in stocks, the recent downturn likely threw your portfolio out of balance. But given the market recovery to date, your asset allocation may be back in line.
So is there a need to rebalance your portfolio? It depends on whether your portfolio’s drifted from your target asset allocation, which you chose based on your goals, time horizon, and risk tolerance.
We recommend checking your portfolio according to a fixed review schedule—quarterly, semiannually, or annually (not daily or weekly). If your mix is off by 5 percentage points or more on your review date, consider rebalancing.
For example, let’s say you have a 60% stock, 40% bond portfolio that you look at once a year. If you’ve drifted to 66% stocks, 34% bonds, it’s time to make some adjustments to get back to your 60/40 mix because you don’t want to be exposed to more risk than you’re comfortable with. On the other hand, you may find that you’re uncomfortable rebalancing back to your target. Maybe your goals or life circumstances have changed, and it’s appropriate to be more conservative. In this case, rebalance your portfolio to align with your new target.
If you don’t have any international holdings or you’d like to rebalance your mix of international versus U.S holdings, remember that diversification is critical to managing risk. By owning international investments, you can diversify your portfolio even more—thus lowering your risk. Given that international stock prices are currently more attractive than U.S. prices, foreign investments have the potential to outperform the U.S. in the near future. Since it’s impossible to know for sure, we recommend holding both—with at least 20% of your portfolio in international stocks and bonds. And don’t forget to rebalance to your target allocation when necessary.
I’m retired. What’s my investment strategy?
If you’re in retirement, here are some things you can do to ease your nerves during these unsettling times:
- Make sure you have a liquidity buffer in cash reserves, such as a money market account, to cover your living expenses for the next 1 to 2 years. However, because money markets typically generate a small amount of income, having too much set aside in this type of account puts you at risk of not keeping up with inflation. So don’t think of a cash account as an investment. Instead, think of it as assurance that you’ll have money on hand when you need it.
- Check your asset allocation and adjust it to ensure your portfolio aligns with your goals, time horizon, and risk tolerance.
- Consider cutting your spending. Given the current stay-at-home mandates, discretionary spending on things like travel and leisure has resolved on its own. Look for ways to further tighten your nondiscretionary spending. For example, are you able to reduce your grocery or utility bill or cancel your cable TV subscription?
Check out What “stay the course” means if you’re retired for more details.
What are some RMD considerations as a result of the CARES Act?
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed into law on March 27, 2020, has made important changes to the rules for required minimum distributions (RMDs) from IRAs and employer-sponsored plans like 401(k)s. It includes a temporary waiver for both 2020 RMDs and 2019 RMDs due by April 1, 2020, for individuals who turned 70½ last year and didn’t take their RMD before January 1, 2020.
“If you don’t need the money, the natural inclination is to keep it in the IRA and let the money continue to grow,” said Bruno. “You participate in the markets and, hopefully, they ebb and flow and go up. The other thing to think about is whether there’s an opportunity from a tax planning standpoint. With RMDs, there are some tactics you may be able to employ and you don’t necessarily have to take the full RMD amount.”
For example, if you’re in a lower tax bracket this year, you may want to take the distribution, or even a portion of it, to lower your IRA balance, which will then lower your future RMDs.
For details on suspending any remaining distributions for 2020, visit What the CARES Act means for you.
We recommend that you consult a tax or financial advisor about your individual situation.
I’m a millennial with cash on the sideline. How and when should I invest in the market?
When investing in the market, many factors determine your best course of action, including your goals, time horizon, risk tolerance for market swings, and overall personal financial situation.
As a millennial, you’re most likely entering the prime of your career, where you expect to earn more over the next few decades. With time on your side, it’s the perfect situation to get more involved with investing. And doing so right after a bear market can be a great time to invest. Over the long term, we typically see stocks go up after a market downturn, and over the next 10 years, we expect them to return 6% or 7%—possibly more for international investments.
IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model® (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from VCMM are derived from 10,000 simulations for each modeled asset class. Simulations as of March 30, 2020. Results from the model may vary with each use and over time.
If you feel like you’ve missed the downturn, don’t wait for the next one before you start putting that cash to work. When it comes to building your wealth, it’s always best to start sooner rather than later. Starting early allows you to take advantage of the power of compounding, which helps to increase the rewards of investing.
To get started, explore our products, consider the keys to successful investing, and find the investments that are right for you.
Is there an argument for investing in actively managed funds over index funds in times of recession?
When you purchase an index fund, you own the whole market, which spreads out your overall risk. Over time, index investing has proven to be a successful way to grow your money. In fact, as of May 31, 2020, Vanguard Balanced Index Fund saw an average annual 1-year return of 11.36%—despite recent market volatility.
Average annual returns, May 31, 2020
Balanced Index Fund Admiral Shares
Since inception 11/13/2000
Investing in actively managed funds offers the potential for market outperformance. “You can find managers who outperform the market over time,” said Vanguard CEO Tim Buckley. “And we’re proud to say we found many of those managers here at Vanguard. If you want to invest in actively managed funds, just make sure the portfolio manager has a long-term view, low turnover, low costs, and a differentiated view of the market.”
Partnering actively managed funds with index funds is a great strategy to broaden and further diversify your overall portfolio.
Are municipal bond funds still considered a safe investment in this current environment?
The municipal bond market saw depressed prices and increased yields and spreads resulting from concerns about a slowing economy and the possibility of municipalities and states getting downgraded. In turn, some investors started selling their holdings because they were worried about loss of principal.
“When it comes to whether or not a state municipality will pay back their debt, the expectations are that they will have the ability to do that,” said Davis.
The Federal Reserve has launched a Municipal Lending Facility to offer up to $500 billion in 2-year loans to states and certain counties and cities, reaffirming our view that the risk of default among investment-grade municipal bonds remains very low.
Davis added, “We think they’re a great long-term investment for clients. They have a relatively low default rate in the grand scheme of things.”
Stay tuned to our market volatility hub for regular updates on the economy and investing.