Over the weekend, reports confirmed the rapid growth of the spread of the Coronavirus outbreak in South Korea, Italy and Iran. Italy, a G7 nation, saw over 220 newly infected with six dead. China also backtracked on its early announcement that it was going to relax travel restrictions. This bad news sent stock markets into a tail spin today, with the Dow Jones Industrial Average (DJIA), S&P 500, and Nasdaq losing 3.55%, 3.35% and 3.71%, respectively.
I have already talked about the Coronavirus from an investment perspective – see here – so that is not going to be today’s topic.
Instead, I want to use today’s panic selling as an example that holding an index fund is not an adequate investment strategy for anyone that wants to feel comfortable with their financial situation. You need to financially educated yourself over time and learn how to invest in different asset classes that are not correlated with each other. What I mean by correlation is that if two things go up and down in exactly the same way then they are 100% correlated. That is a bad thing when you want diversification. Stocks have been shown to be highly correlated with each other when the market corrects.
Remember, an index fund does reduce company-specific risk. Company risk is the specific financial risk you face by holding one company stock. If that company experiences a negative event specific to the company’s business or operations, you will see a drop in the stock price that is unrelated to the overall stock market performance. An index fund reduces this type of risk because it holds a basket of company stocks. However, an index fund does mitigate market risk. Market risks are factors that can affect the overall performance of the stock market that are not specific to a company. The coronavirus is an example of a market risk. Today’s drop in the stock market was due to an increase in market risk.
Here is how a few of the popular stock market index funds handled market risk today. Vanguard’s S&P 500 ETF was down 3.34%. The more conservative Vanguard High Dividend Yield ETF was down 2.7%. A majority of the DJIA stocks were down today and over 95% of the S&P 500 stocks were down. The stock market basically got its ass kicked today due to market risk.
Gold, a different asset class than stocks that is not highly correlated with the stock market, was up almost 1% today. As I mentioned here, I added more gold to my portfolio as a hedge when the Coronavirus got started. It is up almost 7% since I added more in January.
My portfolio that owns just dividend stocks is down 1.9% today. I own stocks in different industries but it did not matter today. Every single stock I own in this portfolio was down today.
However, my larger portfolio that holds various types of assets was down only 0.03% today. This portfolio holds stocks, bonds, real estate equity and debt, and real assets such as gold. I will breakdown this portfolio in greater detail in my quarterly financial update that comes out in April. Today was an example of how my All-Weather Portfolio should hold up better than index funds when we have our next big market correction.
Diversify Among Different Asset Classes
Take a look at your investments. I’m not recommending any panic selling due to today’s stock market drop. However, I am recommending that you consider whether your investments are adequately diversified among different asset classes that are not highly correlated. You will not be able to predict the next market downturn so downside protection includes investing in different asset classes. Get educated on the different asset classes available to you for investment and learn how to invest in them. I will be writing about different asset classes over time to help you learn.