We are probably several years away from Michael Lewis writing the definitive layman’s book on the economic events of the past six months. And while investors will also need a bit of time to unpack the key lessons from this period, data from a large fund manager offer a good start to our learning experience. The Vanguard Group recently released a study on how its investors reacted to the market’s unusual volatility earlier this year. Just to put some numbers on that unusual volatility, recall that the S&P 500 reached a pre-pandemic peak on February 19, fell 34% in subsequent weeks before bottoming on March 23, then rallied more than 36% through the end of May.
One interesting piece of news is that most of Vanguard’s investors did not make any trades at all. Between February 19 and May 31, just 17% of households traded. Keep in mind that previous research has shown that market conditions influence the amount of attention investors pay to markets, and when market-related news reports grow, as they have this year, increased trading activity usually follows. Yes, reallocating funds into stocks as prices fell would have been ideal, but in the face of one of the sharpest economic declines in history, just staying the course was no small achievement.
Unfortunately, though, a small percentage of investors panicked. They liquidated their stocks and bonds entirely and moved everything to cash. For this group, Vanguard calculated two sets of returns: the actual returns earned by panicked investors, and the returns they would have earned if they had not made any changes. Comparing these results through the end of May, Vanguard estimated that more than 80% of these investors would have realized better returns if they had made no changes to their mid-February portfolios. Since markets have continued to rally in the months following the study, the damage to these portfolios has probably grown. The fear that caused these unfortunate investors to act is understandable, but I doubt they understood how costly their actions were likely to be. It would have been helpful if Vanguard had also quantified what happened to investors who liquidated only part of their investments, but I suspect the results would have been similar.
The benefit of owning stocks comes in the form of attractive long-term returns. One challenge of owning stocks is that they tend to be volatile in the short term. Often, this can be hard for investors to reconcile, but allowing short-term concerns to dominate a solid, long-term strategy may be the best way to sabotage the chance of success. This study also reminds us of the important role advisors can play in helping investors stay the course. Because we believe knowledge is the best antidote to fear, we work hard to be sure our clients are well informed and therefore less likely to panic, regardless of market conditions.