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Rejoice, Panic, or Somewhere in Between

Rejoice, Panic, or Somewhere in Between

How to react to dramatic market swings

All right, time to confess…the last few weeks when the markets were dropping faster than the Ball on New Year’s Eve, which of these caricatures did you most identify with?

Follow-up question…which of these caricatures do you think you “should have” embodied?

Let’s dig a bit more into this second question, and evaluate what your response likely should have been assuming the two most basic avatars of our financial life: The Builder and The Protector

The Builder is in the aggressive wealth accumulation phase. He is 10+ years from retirement, and he is saving and investing at least 10% of his income in some way…whether that’s through an employer sponsored retirement plan like a 401(k) or into an investment account (or both). Ideally, this person is a “Super-Saver” and is saving 25%+ of his income consistently over time to steadily build wealth.

When the markets go down, The Builder should be “Joyful Joey” fist pumping the air in celebration. Why? Because he is in the habit of continually buying into the market at relatively regular intervals via consistent saving and investing (this behavior is generally referred to as Dollar Cost Averaging). When the markets drop, equities effectively go on sale – the price per share has decreased, allowing us to purchase more shares for the same cost. As the old investing mantra goes “Buy Low…Sell High”. The Builder should view market pullbacks as a buying opportunity to get more bang for his buck, and he should change nothing about his financial behavior. 

The Protector has worked hard to amass wealth, and is more concerned about safeguarding his assets to ensure he can generate sufficient cashflow to provide for his lifestyle through retirement. He is typically within 5 years of retirement or has already left the workforce. He may still be saving and investing regularly, but not as aggressively. Additionally, the benefits of dollar cost averaging have a minimal effect as his invested asset base dwarfs his annual savings.

If The Protector has planned appropriately, he should be more like “Watchful Wyatt”. He should be aware of what’s happening in the markets in case slight adjustments to his plan are required (more on this below), but for the most part he should maintain the status quo. By contrast, if The Protector has not built his portfolio to withstand market volatility and still provide for his needs through retirement, he very likely embodies “Panicky Pete” who you can almost see running around in circles tearing his hair out. Don’t be that guy! 

 

Appropriate Actions to Take

As discussed above, if you are The Builder, keep saving and investing as normal. Channel your inner “Joyful Joey” and realize that market downturns will very likely help you to achieve your financial goals in the long run. If possible, consider increasing your savings rate during the temporary downturns to further take advantage of the price discount.

If you are The Protector, let’s first evaluate whether your situation should cause you to lean more towards the zen-like “Watchful Wyatt” or the frantic “Panicky Pete”. 

Answer these 3 questions:

1. Do you have enough cash to cover at least 6 months’ worth of living expenses (we refer to this as your “Cash Zero”)?

2. Do you know Your “Number” – the amount of assets required to provide your desired cashflow through retirement?

3. Is Your “Number” invested in a “Pension Style Strategy” – typically 60% Equity and 40% Fixed Income – to give you the best chance of creating and sustaining a lifetime of retirement cashflow? 

If you answered “No” to any of these, the last couple of weeks may have caused you to tear your hair out like “Panicky Pete”. Work to address what you are missing.

If you answered “Yes” to all 3 of these questions, then you very likely identify more with “Watchful Wyatt” and may only consider slight adjustments to your plan (see Steps to Take to Calm Your Nerves below). Should you be faced with the wonderful problem of having more than enough wealth to provide for your needs, then you have a few options to choose from (or a combination thereof): 

Be “Tony Soprano” – dig a hole in your backyard and fill it with cash. This Principal Preservation strategy aims for a return OF principal and not a return ON principal.

Be “Neil Armstrong” – shoot for the moon! This Capital Appreciation strategy allocates excess funds to equities for greater growth potential.

Be “Bill Gates” – pass it on. Work to find creative investment and tax-planning strategies to help support your desired legacy. 

 

Steps to Take to Calm Your Nerves

If you answered “Yes” to the 3 questions above but you still feel like you’re channeling “Panicky Pete”, then let’s discuss what actions you can take to assuage your fears and help prevent you from making a costly, emotionally-charged mistake. 

Perform your Self-Affirmations 

Your portfolio was built, and is continually monitored and updated to address and adapt to periods of volatility. Realize that, as one of our dear clients, you are already prepared for a recession or market decline because your long-term strategy was designed with this in mind. Proactively do nothing different. Keep calm and carry on! 

Double your "Cash Zero" 

“Cash Zero”, or more commonly referred to as an Emergency Fund, is a threshold we always discuss in our Dashboard Planning conversations. We encourage all clients to keep 6-12 months of spending cash in their checking/savings to create a cushion for any unexpected expenses or life events. By segmenting and maintaining a “Cash Zero”, we are prepared for any short-term surprises that may come our way…we can live our lives as usual without having to tap into our portfolio and interrupting our long-term investment plans.

The average Bear Market lasts 1.3 years. If you are truly concerned about the impact of another market correction, then we would recommend you consider doubling your “Cash Zero” threshold, which should equal 12-24 months of spending needs. This amount should likely carry you through the majority an average Bear Market period without having to tap your long-term investments and possibly realize a loss. 

Isolate planned Capital Expenditures now 

If you know that in the next 1-2 years you will have a large expense in excess of your typical spending (large family trips, new windows for the home, new car, basement renovation, education costs, etc.), let’s “spend the money now” by earmarking needed funds and setting them aside. These expenditures are truly short-term in nature and have no business being invested in the equity markets. By carving out these amounts from the portfolio, it often gives us the psychological edge of a longer-term perspective. 

Align your investment philosophy and investment reality 

This is the difference between “knowing what you got” and “understanding what you got”. If the sticker shock of a drop in the total value of your portfolio makes you crazy, then maybe we should challenge your overall strategy and investment allocation. It is fairly easy to dial down the risk profile of a portfolio by increasing the allocation to Fixed Income investments, which should help to mitigate overall volatility. However, it is critical that we strive to ensure your future financial independence by maintaining a necessary allocation to Equities to provide long-term growth potential. Always remember, your plan is comprehensive and extends well beyond some arbitrary portfolio balance on any given day. 

Don't mistake molehills for mountains 

The last time you were on a plane, did you insist the pilot make an emergency landing during a patch of turbulence? The last time you were sitting in gridlock traffic on your way to work and saw a commuter train whiz past you, did you get out of your car, sell it on the spot, and walk to the next train stop? As silly as these examples sound, they aren’t too far off from the behavior of a rattled investor making panicked decisions governed by fear. This latest scare with the coronavirus (COVID-19) truly is no different than any other trigger that sends the markets into a tizzy. While the situation with coronavirus will very likely get worse before it gets better, it will eventually get better and activity will normalize. 

We’ve discussed the impact of fear on investing many times over the years because when fear drives our decisions mistakes are made. We believe the best approach to combat fear is open and frequent communication around your personalized strategy and long-term plan. We must always remain steadfastly committed to our long-term goals of building real financial independence and continue to invest into properly risk-aligned portfolios.

The next time you feel yourself start to turn into “Panicky Pete”, give us a call so we can continue to discuss what your personalized plan looks like, the calculated risks we are taking, and how we should either tweak, hold, or add to the portfolio when appropriate.