Fight or flight? These two basic responses to a perceived threat served our ancestors well, but in today’s modern world most people do not face life-or-death situations in their day-to-day that engages their fight-or-flight instincts.
Except, of course, when it comes to the stock and bond markets, where, at least according to many commentators, investors are constantly fleeing to safety, or selling first and asking questions later.
The fight response might be more appropriate, though. Consider that the U.S. stock market has been in a bull market for more than six years despite myriad Wall Street “scares.”
Here is an incomplete list of perceived threats that were said to have forced some investors to flee:
Affordable Care Act (or Obamacare, if you wish): Passage would kill the health sector
Arab Spring: Middle East chaos
China slowing: Global demand would suffer
Comparisons with 1929: The charts say Depression
Cyberattacks: Corporations aren’t safe
Cyprus: Bank defaults would lead to global disaster
Ebola: A global pandemic
Flash Crash: The markets are unsafe
‘Grexit’ Parts 1 and 2: The demise of the EU and the euro
Isis: A world in chaos
Libya: More Middle East chaos
Quantitative easing: Leading to hyper-inflation
Sequestration: The U.S. government in chaos
Tapering: Without stimulus the economy would crater
Ukraine, Crimea and Russia: Chaos and war-mongering
U.S. debt rating downgrade: The U.S. is in trouble
U.S. Government shutdown: The U.S. is in trouble
Clearly, the list of reasons to avoid the stock market is ever-expanding, and yet investors have been much better off staying in the markets.
Flying to safety is just another way of saying that investors are timing the markets — something has happened, and they are trying to get out of the market before it gets worse, with the idea of getting back in after the danger is gone.
Only it rarely works that way. As the list above shows, predicting what will actually spark the next bear market is not an easy task. And don’t forget that to be successful in this endeavor, you need to not only avoid the danger, but get back into the market afterward.
You’re better off moving away from the all-or-nothing mind-set of fight or flight. Taking flight hasn’t served investors in the long run, but sticking to your long-term plan shouldn’t be a fight either. Rather, the right response is usually to be patient and realize that the apparent threat often is not as dangerous as first perceived.
Still, the flight-to-safety instinct is a strong one, and we eventually will see another bear market, so let’s discuss (and dispel) common funds investors turn to for safety. These flight-to-safety funds, when added to a stock-heavy portfolio, can help make it easier to stick to the plan when your instincts tell you to fly.
Shock-Absorbing Funds
Vanguard Intermediate-Term Treasury (MUTF:VFITX): There are plenty of naysayers and doubters, but until proven otherwise, U.S. Treasuries remain the flight-to-safety asset of choice. You’ll get the most bang for your buck in terms of protection from falling stock markets in long maturity Treasuries.
Consider that Vanguard Extended Duration ETF (NYSEARCA:EDV) gained 55% in 2008 as Vanguard 500 Index (MUTF:VFINX) lost 37%. Or take the third quarter of 2011, when Vanguard 500 Index lost 13.9%, but Extended Duration Treasury ETF gained a whopping 52.7%.
That’s certainly a lot of return to offset declining stock prices, but those returns can slice the other way. Extended Duration Treasury ETF declined 35.7% in 2009 and dropped 17% in just the three months ending July 2013. Not exactly what I would call a “safe” holding.
If you are looking for Treasury bonds to insulate your portfolio, I’d look to Vanguard Intermediate-Term Treasury, which has regularly provided positive returns when stocks fell but without the wild ride of long-maturity bonds.
