In any eventful year, there are opportunities to learn. While you can easily finish with the wrong takeaways, 2020 was instructive, if you’re willing to listen to it. In the events of this year, the jagged teeth of the market, the rising cases of coronavirus, the declining jobs, and the soaring S&P 500 (^GSPC), some important takeaways emerge.
Nobody can see the future
If there’s one overarching lesson of the year, it’s that no one knows what’s going to happen. Certainty has frequently been rewarded with a cruel sense of humor throughout history, and this year saw everything change in stark ways that everybody knows all too well.
Back in March, economists, politicians, and investors laid out scenarios of the potential impact of the coronavirus on the economy, public health, and the stock market — as well as how society might have to respond. The median forecast was not accurate; the median 2020 S&P 500 outlook was for just a 2.7% gain.
Some S&P 500 predictions were decent-ish: Piper Jaffray saw the S&P 500 at 3,600. Fundstrat and BTIG were the next most bullish at 3,450. Goldman Sachs guessed 3,400. UBS and Morgan Stanley guessed 3,000. But of course, nobody’s estimates factored in a global pandemic.
Forecasts are easy to pick on, and at their best, they’re not meant to be crystal balls but tools to use like any other. Forecasts can be useful in a “if things continue on this path, this is where we think we’ll be” manner, but when a global pandemic is unfolding, their utility is questionable. And to their credit, many forecasters withdrew guidance.
This humility looks extremely good in retrospect.
Imagine if someone had a crystal ball, and the knowledge that the country would be slammed by well over 300,000 dead and almost 20 million cases by year end. Would they still have expected the S&P 500 to be up almost 15% after dropping over 30%? Probably not.
This isn’t to say that predicting is always futile. A lot of people predicted the coronavirus would come and cause a huge problem in the U.S. Those predictions were useful, not necessarily as measures of probability but first and foremost, as warnings about icebergs ahead.
Unthinkable things can happen
Back in February after watching the coronavirus emerge and spread in China, there’s no doubt some people were sounding the alarm that this could cause a huge global problem.
But as people like Mohamed El-Erian warned investors, stock prices continued to suggest a collective denial, peaking in late February long after the virus had reached our shores and began spreading.
Too many thought it couldn’t happen to us, as if an American exceptionalism would save us from a virus that eventually hit the vast majority of countries on the planet. The government and politicians were not prepared, and the public — and investors — didn’t come around to how awful this would really be until well into March when the market hit bottom.
This isn't limited to pandemics. History has many examples of once unimaginable events occurring, and this year's pandemic is just the latest one. The future is likely to remind us again that the unthinkable can happen.
Markets are not necessarily intuitive
If predictions are hard to make, they’re also hard to understand, perhaps best illustrated by the fact that had you known the future of the virus or where employment is, you would probably not have imagined the stock market where it is now.
As Wall Streeters have often said, the market is a narrative — a collection of stories — predictions and hopes. That’s it.
On the one hand, it’s sometimes easy to explain things, like how earnings expectations drive the market and how the “real economy” like unemployment and wage growth isn’t necessarily connected to the rising indices. But the market often doesn’t make sense, like when suddenly individual investors suddenly decide nothing is hotter than bankrupt companies’ stocks and go deep into Hertz and cause a “great disconnect between fundamentals and finance,” as El-Erian put it.
Dollar-cost averaging is a good strategy
If the market’s craziness vindicated one investment idea, it was dollar-cost averaging. The practice of buying stocks (or other securities) at regular intervals to smooth out the market’s contours rewarded investors who didn’t try to time their moves just right. At the end of March, the market fell and rose over 5% many times, providing an intoxicating opportunity for someone to buy the dip or a mini dip. Of course, they didn’t know what the bottom would be — or even if there would be another in a few weeks, leaving a lot of cash on the sidelines.
Dollar-cost averaging people, on the other hand, with a stress free buying schedule, often via their 401(k) contribution, simply kept buying regularly and are sitting pretty having purchased all spring and summer, well before these all-time highs.
Rebalancing works
For people who didn’t necessarily have cash on the sidelines, portfolio rebalancing would have been a great strategy. As the market fell, everybody’s breakdown of assets moved as well. If you’d like your portfolio to have 75% stocks and 25% in safer assets, but the stocks just got hammered 30%, you might be left with just 68% in stocks, far less than your goal.
A rebalance after the crash in March would have led you to buy more stocks to get back to 75%, leading to a favorable position to enjoy the gains of the rest of the year. (If you did that, you’d probably be more stock-heavy than you want to as well, and would be wise to rebalance again to stay at your goal allocation.)
The market will probably be bigger later
A consensus on Wall Street (and, frankly Main Street) is that the stock market is almost certainly going to rise over the long run. This underpins everything from target date funds to more intense asset management. Over any 10 years, the S&P 500 has only seen negative returns once, the decade that ended in February 2009.
When the market crashed in late March, people not only continued to dollar cost average to smooth out their exposure to fluctuations, but many long-term investors also decided to increase contributions or bought stocks, effectively buying the dip. According to Fidelity and Vanguard, long-term investors didn’t flinch — and many actually took advantage of the market’s low prices. Even if they didn’t expect all-time highs so soon, it wouldn’t have been unreasonable to expect them sometime within the next few years, a reasonable timeline for a long-termist.
Capital gains taxes matter
A key narrative of the year was how the pandemic poured fire on the Robinhood investors, who, thanks to $0 trading commissions, rediscovered day trading. One lesson that hasn’t come home to roost yet — but will — is that day traders capital gains will be taxed on the short-term schedule, giving a nasty surprise come tax time, since taxes aren’t usually withheld for realized gains.
Investments that are owned for over a year are taxed as long-term capital gains that have rates far less than ordinary income — which is how short term capital gains are taxed. That means any day trader will see higher tax bills than longer-term investors for a similar gain, and underscores why tax planning is important. As Ritholtz CIO Barry Ritholtz puts it, every investor has a “silent partner”: the government.
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Ethan Wolff-Mann is a writer at Yahoo Finance focusing on consumer issues, personal finance, retail, airlines, and more. Follow him on Twitter @ewolffmann.
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