7 Investing Rules Of Thumb You Should Retire Right Now

As markets have swooned and strutted in the COVID-19 pandemic, investors may have found their eyes bouncing up and down in time with the S&P 500, Dow, Nasdaq, and Russell 2000. What’s the next move to make? A smart thing to do?

One is to start putting old-time rules of thumb and generalizations to the side. “This is not a routine recession,” said David Waslen, CEO of HedgeTrade. “We’ve never experienced this mix of macro events before. Extra caution is really a necessity, as well as finding ways to insulate your portfolio from the effects of the market downturn and COVID-19.”

I heard from dozens of investing experts about what regular strategies people should reconsider. Here is some of the most popular advice that kept popping up.

Sell in May

The old “sell in May and go away” adage—that you reconsider your individual investments and the balance of your portfolio in the period from May through October—was based on experience. “[T]hese six months have historically been some of the worst six months of the year,” as Ryan Detrick, senior market strategist for LPL Financial wrote in a note that I received. But things have changed in general, with stocks doing better in that assumedly fallow period in seven out of the last eight years. Here’s a chart based on LPL’s data:

LPL is still betting on a short recession and a “much stronger economy later in 2020.” I question the projection, as the depth of unemployment will have long-lasting effects and implications. But, forecasting aside, there is additional sound logic to reconsider this advice now.

“While this is a popular statement and has a little validity (at least technically) selling this year could be devastating in the recovery of your portfolio,” said Justin Goodbread, founder of Heritage Investors. “If you follow the old idea of selling all positions in May and waiting until October to reinvest, then you may miss a single larger recovery day and set your portfolio recovery back years.”

Realistically, you could also take part in a big slide if that happens, as it has in some other notable downturns that lasted longer than anyone expected and offered a series of recoveries and drops, as you find with blow-off tops. But even in the worst times, markets have come back within a few years. It depends on your liquidity, but more on that in a bit.

Buy the dip

Another classic bit of advice for a downturn is to buy dips and wait things out. “That is the panacea offered to every investor that has the time to let their assets grow in order to rebuild wealth,” says Kelly LaVigne, vice president of advanced markets for Allianz Life. “But not everyone has the time necessary to completely make up for the losses they’ve suffered over the past month, and furthermore, it’s a mistake to move forward without incorporating lessons learned from recent events.”

There’s no telling how broad changes in the economy—and make no mistake, there will be significant ones—might ultimately shake out. Some companies that have done well may see long periods of poor performance. As David Reyes, financial advisor and chief financial architect at Reyes Financial Architecture put it, further drops are “usually more methodical” but can be “just as or more damaging” than the original one. “This is exactly what happened in the 2000-2002 bear market and in the 2008 financial crisis.”

It’s also what happened in the Great Depression, when the Dow took a big dive, regained about half of what it lost, and then went skidding down for years, as the graph below shows (data from S&P Capital IQ):

When Warren Buffett dumps all holdings in four major airlines, you can bet that there is a limit to buy and hold, a strategy that assumes a high degree of continuity in business and economic conditions.

Age-based investing

Pegging asset allocation purely to age is “crude even in the best of times,” noted David O’Leary, founder of Kindwealth.ca, “but given how low interest rates are right now—and likely will be for the foreseeable future—you may not be able to afford to keep as much fixed income in your portfolio as this rule of thumb would suggest.”

According to the formula, as O’Leary pointed out, a 40-year-old might hold 40% in fixed income and “expect to generate meaningful returns.” But which bonds would you hold? Corporate as credit ratings drop and risk increases? Treasurys, when the 30-year has been on a decades-long downward trend and real return rates (after inflation) for 5-year and out are all negative?

That doesn’t mean to ignore bonds, but recognize that their traditional strength has a gains hedge against equities may have diminished.

4% withdrawal rule

“The 4% withdrawal rule … advises that retirees can be confident taking 4% out of their retirement funds every year after they stop working to cover living expenses,” said Pam Krueger, CEO of Wealthramp and co-host of PBS’s MoneyTrack. “It generally works in all kinds of markets, but in this strange new world, investors must be careful to focus on their own individual circumstances. Women especially have to be mindful about not following this rule-of-thumb because they live longer into retirement and have more years to draw down.”

Again, this becomes particularly relevant in a time of historically low interest rates.

ETFs and index funds

Passive investing has gained a lot of interest for its ability to outperform many actively traded alternatives, particularly when considering comparative costs of the two categories. Index funds and most ETFs let someone put money into what is supposed to represent a broad collection of stocks and then benefit from the inexorable rise over time.

The “over time” part is today’s potential investment killer. If you have a long horizon, all might be fine. If not—another case for considering your liquidity—perhaps not.

P/E shopping

Many investors use the price earnings ratio as a key to stock picking, comparing it to historical averages. This assumes some continuity in markets. While never a sure thing, this approach is far less so now.

Earnings—the denominator of the ratio—are “usually based on the estimated earning for this year,” said Michelle Connell, owner of Portia Capital Management. “[But the] ability to estimate earnings for 2020 just went out the window. Even if companies are still providing guidance, their ability to generate earnings is still a big unknown. Tech stocks can command a higher P/E ratio because they grow faster. But even some tech names are looking at slower growth rates and may deserve a lower multiple.”

There is also an increased risk in companies. “We know that half of investment-grade debt is in the lowest range of credit ratings and several of these companies will have trouble paying or renewing their debt,” Connell added. ”For those in this category, it will not be business as usual.”

In fact, for a still unknown number of companies, it’s going to be business not at all.

You can and should apply the same scrutiny to entire indices. With the big drop that started in February, so did last-twelve-month (LTM) P/E ratios for the S&P 500. They were 22.6 in the first quarter of 2019. As of May, that’s down to 20.43. However, the value is still well over the roughly 15 to 16 average over the years and is unlikely to have incorporated expected falling earnings, so stocks are far from cheap.

Dividend stocks in a recession

In recessions, one standard recommendation is to shift investments to stocks that pay dividends. The guaranteed income provides at least something in a return, even if market value of shares drops, as the theory goes.

“But in today’s financial climate, we’re seeing companies like Shell cutting their dividends for the first time ever,” Waslen said. “If you’re a preferred stockholder, you may have a better chance of dividend payouts, or even get paid later when—or if—the company has a comeback. Some exposure to government bond ETFs may provide a better long-term outlook for receiving dividends.”

In other words, we all need to rethink what was considered safe and virtually automatic strategies. Time for some research and trusted advice.

This article was written by Erik Sherman from Forbes and was legally licensed by AdvisorStream through the NewsCred publisher network.