Given the outcome of yesterday’s referendum, which calls for Great Britain to leave the European Union, the question is what’s next? The only honest answer right now is “we don’t know.” BBC News has a good article explaining the vote and the exit process.
No country thus far has left the European Union. Greenland previously negotiated an exit from the European Union, but Greenland is a semiautonomous territory of Denmark. There are rules regarding an exit from a member country, but they’ve never been used.
BBC News says the referendum is “not legally binding.” Parliament has to pass laws to get Britain out of the EU. The withdrawal agreement also has to be ratified. In the background of this are the political ramifications of Prime Minister David Cameron’s resignation, renewed calls for Scottish independence and even possibly discussion about Irish reunification. There will certainly be more opinions about British politics than those who truly have insights.
From the standpoint of investors, particularly those of us here in the United States, the best move you can make for your portfolio is not to react. Yes, there has been an immediate reaction in the global markets (including a big drop at the start of today’s trading in the U.S.), but we simply cannot predict how the equity markets will look six months from now, much less one year, two years or five years from now. There will be those who will make forecasts this morning, but just a few months ago, there were many who also predicted the Federal Reserve would announce four interest rate hikes this year. Crystal balls simply do not work, especially when it comes to predicting what the financial markets will or will not do over a given period of time.
There is also a psychological reason to not do anything. Our brains are reactive, making decisions based on mental shortcuts rather than working through the full logic. As such, your initial decisions are likely to be different than the ones you would make if you sat down and thought out your long-term strategy.
If you are worried or just want suggestions on navigating a Brexit world, here are some tips.
- Don’t Panic: One of the most harmful things you can do to your wealth is selling stocks out of fear about what could happen. As I explained in The Danger of Getting Out of Stocks During Bear Markets, doing so will result in a massive loss of potential wealth—a gap so large that you may never be able to close it.
- Maintain a Stash of Cash to Cover Living Expenses: In his forthcoming book, “Investing at Level3,” AAII founder Jim Cloonan recommends that retirees maintain a balance equivalent to four years of living expenses in safe assets (e.g., cash, short-term Treasuries, etc.) Doing so will allow you to avoid selling stocks during a downturn. It may also help you avoid panicking.
- Pay Attention to the Long-Term Performance of the Stock Market: Since the late 1920s, large-cap stocks have realized an annualized return of about 10%. These long-term gains have occurred despite two world wars, an oil embargo, the threat of nuclear war, a massive depression and, more recently, a global financial crisis. Yes, there have been severe downturns, but those who didn’t panic fared well.
- Make Note of How You Currently Feel About Your Stock Today: No questionnaire can reveal your tolerance for risk the way scary headlines and a market drop does. Keep a log of how your emotions are today. Do you feel a strong urge to sell? Are you trying to read as much you can about Brexit so you can figure out what to do? Alternatively, can you resist the temptation to do anything or even find yourself looking for buying opportunities? The answers will shed light on how much price volatility you can truly withstand. It matters because the optimal investing strategy is the one you can stick with over the long term.
- Most Importantly, Do Nothing Right Now: As I previously explained, your brain is likely to be in a reactive mode. Exiting the EU is a lengthy process and nothing is set in stone, so don’t feel rushed to make any changes to your portfolio. Rather, take a deep breath, enjoy the summer weather and then think about what course of action (including taking no action) will be in the best interest of your long-term wealth.