No one could have foreseen the impact of a sudden pandemic on the world’s largest economy. The damage has been widespread with no industry and few individuals escaping the economic carnage. Of one thing we can be certain, the way people view the world and, more specifically, the way they view their investments, will forever change. While investors who held firm through the recent stock market rollercoaster ride have seen their portfolios recover most of their losses, the horrific experience is causing many to reassess risk in a way we haven’t seen since the 2008 financial crisis.
Like Trying to Fix a Roof During a Storm
But is it too late? President Kennedy once said, “The time to repair the roof is when the sun is shining.” Borrowing loosely from Kennedy, wouldn’t the best time to evaluate risk be when there is little or no apparent risk present in the market? It’s easy to become complacent when the stock market is hurdling to new heights for 11 years. If a portfolio was your house and there was no sign of rain, you might put off fixing that hole in your roof. But now, amid a storm with water pouring through the roof, you may be wishing you fixed the roof back when the sun was shining.
The problem is you just can’t shrug your shoulders and ignore the hole. You have to find a way to plug it, or the situation is only going to worsen. Now, in the midst of this storm, investors are forced to reevaluate their portfolios in terms of risk and return – a task much more easily and effectively performed when the markets are calm.
Perhaps the most noteworthy example of trying to plug the roof during a raging storm is when Warren Buffett sold all his positions in the airlines last February and March. Over the last several years, he made an uncharacteristically big bet on the airline industry, owning at one point outsized positions in the four major airlines. Of course, the pandemic hit, and the airline industry seized up. Buffett’s attempt at plugging the hole in his portfolio resulted in losses of billions.
Unfortunately, that’s how many investors approached the problem, by selling their equities at a loss, fearing the problem would get worse. As with Buffett, a part of fixing the roof, or at least minimizing the damage, is acknowledging that mistakes were made and recommitting capital to better investments.
The Case for Using Individual Stocks to Fortify the Roof
For those roof pluggers now questioning whether they should be investing in the market at all, the answer is probably not. But, there has perhaps never been a better time for investing in individual stocks, and that’s not a contradiction. Consider this: If, in the current environment, you look across the landscape of industries that make up our economy, would you be able to invest in each of them with equal confidence? What if your portfolio includes stocks in the energy or real estate sectors? Or stocks in the travel and leisure sectors? What about stocks of companies with 50%, 60%, or 80% of total capitalization in debt? What happens when their revenues and earnings evaporate during this or any other economic crisis, and they still have to make those debt payments?
As a result of COVID-19, the business models of many S&P 500 companies have come into question. These aren’t the stocks you want to own when trying to fix the hole in the roof of your portfolio. They are the hole.
But that’s what you get when you own a stock index. With a stock index fund or ETF, you are essentially investing in the market, with no control over the risk and volatility it delivers. You live with the good and bad stocks. Their performance may offset each other, but then you end up with average at best. As we’ve seen this year, if the market falls by 30%, so does the index fund.
While it’s difficult for most stocks to escape the contagion of a market freefall, some do fare better than others and, some are positioned better than others to lead a stock market recovery. That’s the beauty of being able to discriminate through individual stock investing. You can simply decide you’re not going to own any companies in troubled industries. You don’t have to take the bad with the good. You don’t have to hope that there’s some good garbage somewhere in that trash can.
Finding and selecting high-quality companies in which to invest does require energy and effort, mostly in the form of a sound process with extensive research and fundamental analysis. It also requires patience, discipline, and confidence in a strategy to stick with it.
If you can find 10 or 12 high-quality companies selling below their intrinsic value, you can achieve all the diversification you need while regaining control over the amount of risk and volatility in your portfolio. More importantly, you can invest in a strategy designed specifically for you and your objectives, which can instill much more confidence in the strategy. Much more importantly, a portfolio of well-selected stocks can be a preemptive strategy that anticipates the next major storm and fortifies it with a solid roof.
