So we’re all poorer, right?
The S&P 500 SPX, +1.49% stock index has fallen 10.2% over the past nine trading days. Yet all we’ve done is give back a sliver of the huge gains notched since 2009. My contention: Not only is much of the handwringing unjustified, but arguably it’s also wrongheaded.
Seasoned investors don’t get nervous when the market declines. Rather, they get excited by the prospect of buying shares at much cheaper prices. So far, there hasn’t been much to get excited about because valuations remain rich. One indication: Despite the 10% slide, stocks are still trading at 23.5 times 2017’s reported earnings, 22% above the 50-year average of 19.2 times earnings.
Yes, stocks have surrendered a tenth of their value. But the reality is, our stocks and stock funds are typically a small part of our overall net worth. We might also have bonds, cash investments like savings accounts and certificates of deposit, our future Social Security benefits, any traditional pension plan we’re entitled to, our home and our income-earning ability. Add it all up, and you’ll likely find your net worth has barely declined over the past two weeks.
For those of us still in the workforce, our most valuable asset is usually our so-called human capital—our ability to pull in a paycheck. Often, when stocks tumble, it’s triggered by fears of recession, so we potentially face the risk of losing our jobs, even as we lose money on our stocks. But that isn’t the fear this time around. Quite the contrary: With unemployment at 4.1%, some pundits are worried the economy may overheat, driving up inflation and interest rates.
Even as we admire all our assets, we should acknowledge our debts.
Those subtract from our wealth—and leverage any gains or losses in the value of our holdings. Suppose you have $600,000 in total assets, comprised of $300,000 in stocks and a $300,000 home. But you also have a $250,000 mortgage, so your net worth (assets minus debts) is $350,000. If your stocks lost $100,000 of their value, your $600,000 in total assets would fall 17% to $500,000, but your $350,000 net worth would drop 29% to $250,000. This sort of leveraged loss isn’t necessarily a problem, provided you keep your job. That will allow you to continue servicing the mortgage, so there’s no risk you’ll be forced to sell stocks to make the monthly house payments. What if you fear you could get laid off? It may be time to beef up your emergency fund and deleverage your financial life.
For 48% of American households, the past two weeks have been a nonevent, because they don’t have any money in the stock market. Instead, for most Americans, their biggest “investment” is their house. Some 64% of families own their home and, as best I can tell, the housing market remains buoyant.
If we’re employed, we have paychecks ahead of us. Those paychecks are a source of future savings, which we can think of as a chunk of cash that’s yet to be invested. Once we factor in that cash, our portfolios may be far more conservatively positioned than our current asset allocation suggests—and a big market drop could be a huge plus, because it’ll allow us to invest those future savings at lower prices.
It’s hard to be so sanguine if we’re retired or close to it.
When markets tumble, our emotional time horizon often shrinks, and we obsess over every rise and fall in the market averages. My advice: Add up the money you have in bonds and cash investments, and compare that sum to the income you need each year from your portfolio. In all likelihood, you could go many years without selling stocks. Still not comforted? Also ponder which expenses you might cut, should shares continue to tumble. That would give you additional financial breathing room—and even less reason to fret over swooning stock prices.
This column was reprinted with permission of Humble Dollar.