By Timothy Kenney, CFP
2020 has been an extremely difficult year for everyone. We began with the wildfires in Australia, then a global pandemic, followed by massive social unrest. On top of that, we also have an election coming up and the political discourse has been ugly. For those of us that are managing our investment portfolios, paying attention to what has been happening in the market has almost been an afterthought with all the other events going on in the world.
Handling a Bear Market
The threat of coronavirus and the subsequent lockdown of the country caused the quickest bear market of our lifetime to occur within weeks this past spring. While we were trying to focus on keeping ourselves and our loved ones safe, some investors, who were probably on edge to begin with, started selling their stocks. It makes sense – our brains are wired to feel a 25% loss much more than making a 25% gain.
So how many sold stocks during this period? According to Bank of America, assets in money market funds spiked by more than 28% year to date, reaching well above $4 trillion in May. This was the highest amount on record, even higher than the financial crisis. As of today, the S&P 500 has rallied 42% from its lows in March and is now within striking distance of all-time-highs again. This leaves those investors wondering what to do next. So, if you are one of those people, what should you do now?
Re-evaluate Your Investments
The professional mutual fund and hedge fund managers did not see the coronavirus or the subsequent bear market coming. They also did not see the recovery happening this quickly either. Heck, Warren Buffet did not even get a chance to put any money to work. The markets humble us all.
Why are you investing?
It sounds simple but answer this question first because surprisingly few people do. We tend to start with analyzing the market conditions first, then designing our portfolios. We see where interest rates are, start following economic trends, look at sector valuations, and start to plug in investments that make that most sense. These are all important factors to consider when designing a portfolio, but I would argue this approach is precisely backward. You need to start with why you are investing in the first place then design a portfolio from there.
Most people are investing to fund retirement, but do you know how much you need to live on when you do? What about other goals, like travel, a second home, or leaving a legacy for your children? Sometimes it is better to think in those terms than looking at your account statement. If you are 55 and know your goal is to be able to retire and travel around the world by 65, maybe you can think of your investments in terms of those goals: That account is for my travel in retirement. To help my grandchildren buy a house someday. To fund my monthly expenses when I am 75. The markets have always been risky but what is the bigger risk, losing money now or running out of money later in life?
What can you handle in your investment portfolio?
All in or all out is not a great strategy. Once you have determined what you are investing for, try to stay diversified with an asset allocation that you can handle. If this crisis caused you to rethink your asset allocation strategy and keeping a larger allocation of your portfolio in cash or bonds this is probably not a bad thing – you will be better prepared for the next time this happens.
When you invest again, how will you put your money back to work?
Having a lump sum in cash must be one of the hardest mental situations to deal with in investing. The market keeps going up and you kick yourself for being out of it. The market goes down and you think it will just keep going further. No one rings the bell at the top or bottom and ultimately you end up paralyzed. I had several clients with cash on hand this spring. Not a single one put money to work. I had clients that sold in 2008 and got so used to having their cash that they never got back into the stock market. Those are the kinds of decisions that can radically change your lifestyle in the future.
If you are looking to put money back to work, it is more of a psychological decision than an arithmetic one. Since the market goes up on average 3 out of every 4 years, you are probably better off in the long run putting your money back to work all at once. However, this is probably not advisable if your inclination is to sell again once the news gets bad again. Dollar-cost averaging a bit over time probably makes the most sense. How long? Up to you – but the best bet is to set a schedule and stick to it. Once a quarter for a year, once a month for six months, it is up to you. What is important is not the length of time or dollar amount, just that you stick to whatever schedule you choose regardless of what you are hearing in the news.
What will you do in the next financial crisis?
There is always a good reason to sell. Valuations are too high. There is an election coming. The reality is that there has always been stock market volatility and there will be in the future. On average we get 10% peak-to-trough drops in the market once or twice a year. Bear markets of 20% corrections or more happen about once every 7 years. It seems like once a decade some low-probability event happens that no one is prepared for which causes stocks to drop 35% - 50%. If you are 65 you may see this happen at least a few more times.
The easiest way to get through the next tough period is to know that you have planned for it. You have done the homework and know why you are investing in the first place and identified the goals the investments are meant to pay for. You know about the frequency of market corrections and recessions and have an asset allocation that you can handle. Then, the next time the bear rears his head again, you will be ready.
About the author: Timothy Kenney, CFP
Timothy Kenney, CFP®, is the founder of TK Pacific Wealth, Inc., a fee-only financial planning and investment management firm located in Cardiff by the Sea, Calif. Tim is a former fixed income trader with LPL Financial and currently helps clients navigate the transition from work to retirement. Tim specializes in working with stock option recipients and ex-military both locally and across the country.