Major market corrections are scary. If you are close to retirement – or already retired – seismic shifts in the market can feel like the world is ending and your ability to meet your financial objectives is evaporating. If you have a financial plan, now is the time to review it, consider the impacts it has had on your portfolio, and assess in a non-emotional way whether your goals have been affected.
Your financial plan should assess multiple different scenarios and pathways your portfolio can take until, and throughout, your retirement. It is not enough to assume your portfolio makes, say, a 5% return annually and apply that rate of return year-in and year-out, forever. If you are invested in stocks – or anything that could be expected to return 5% in the current environment – your portfolio will be volatile. Some years will be highly positive in the double digits, and some years will be negative, quite possibly sharply negative on occasion. While it can be difficult to assess long-term expectations for investment returns in a period of very high volatility, this is a good time to ask whether you now expect your portfolio’s long-term return to be higher (or lower) than projections originally indicated. Does a major correction this year mean you expect future returns to be higher, lower, or the same?
The crisis has also brought to light the issue of liquidity. Many people, some of them unexpectedly, now face the issue of being forced to liquidate investments at depressed prices. In the long run, this is not a major concern. If you draw funds and make sales from your portfolio monthly, then you made sales as prices climbed higher and higher through 2019 and early 2020 until hitting their peak (so far) in February of this year. Over time, you will end up with the “reverse” of dollar-cost averaging by selling some assets at strong prices, and others at lower prices. The major concern here is panic selling. People are, understandably, worried. Our experience over the past 28 years, including during three major market downturns, has taught us that it is almost always a bad decision to sell after the market has taken a big fall. Much ink has been spent noting that missing only a handful of positive days has substantial negative impacts on a portfolio’s return.
If you are very anxious about your portfolio, the best course of action is (after closing Twitter and turning off CNN) raising enough cash to cover a year or two years of expenses or liquidity needs. By doing so, you ensure that you won’t have to sell any more investments at depressed prices even if prices continue to fall, and you’ll allow your portfolio enough time to hopefully make a significant recovery, while leaving most of your assets invested. Timing the market is impossible – the biggest gains in the market almost always occur when investor sentiment is very pessimistic. Moving a big chunk of your portfolio to cash before an unexpected market upswing can be disastrous.
A simple example can explain why even a seemingly minor mistake can have huge impacts on your long-term results and expectations. Take an investor who needs $60,000 of annual income from a $1,000,000 portfolio and needs the money to last for 25 years. At a 5% rate of return, this portfolio is usually enough, while leaving a little money left over at the end of the 25-year period[i]. But what happens if 10 years in, the investor panics in a market selloff, electing to hold cash and earning no return for that year? Keep in mind, missing just a couple of good days can have this kind of impact. Even though the return was still positive for that year, and even though it affected just one year out of 25, the compounding effects of this mistake mean the portfolio is now expected to be depleted fully two years earlier. Of course, one might argue that missing bad days could have the opposite effect. While true, our experience has overwhelmingly shown that investors virtually without exception move funds to cash at inopportune moments.
As the saying goes, “failing to plan is planning to fail.” In turbulent times, you should be able to reflect on a thoughtful financial plan that defines your objectives and the course required to make them into a reality. If you don’t yet have a financial plan, this is as good a time as any to get started. Feel free to reach out to me to start the process. We offer free financial planning services to all clients of Baskin Wealth Management.
[i] It is worth reiterating that this is an oversimplified example – as stated earlier, average returns are only averages! Yearly returns fluctuate. Panic selling in reality might make a bad year worse, or turn a very good year into an average one.