You Panicked: Now What?
Recently, I was talking to someone who asked what I do for a living — so I explained to them how I’m a financial planner, and I help people retire successfully.
Upon hearing what I do, this individual told me how, amongst the COVID-19 commotion in March, they pulled all their money out of the stock market.
This got me thinking about a few things:
First, I was drawn back to some of the client conversations I had earlier in the year surrounding their investments.
Thankfully, despite a few difficult conversations, all our clients stayed invested — and they’re happy they did!
It also got me thinking about how many people — both do-it yourself-investors and people working with advisors, (like the individual I mentioned above) got scared, panicked and abandoned their portfolios and plans over the last few months.
So if you’re among those people, now what?
The Real Risk to Your Retirement
You need to start by understanding the real largest risk to your retirement.
Hint: it’s not the risk of losing everything in the stock market (assuming you have a well-diversified portfolio).
The most substantial risk to your nest egg is the erosion of purchasing power over a 30 or 40-year retirement.
People forget to consider inflation because it’s been relatively low over the last couple decades. We can go more in-depth on historic inflation rates another time, but for now, let’s agree that stuffing your money under the mattress will not cut it for your retirement goals. That cash will be worth less the further you get into retirement. Just think about the cost of bread, milk or even beer/wine when you first moved out on your own, compared to today. That is the effect of inflation.
For the DIYers who panicked: now is the time to ask, “do I have a clear investment and retirement plan” and “should I be talking to a financial advisor?” An advisor doesn’t just help you build a portfolio; they’re also there to serve as a coach and a person to bounce ideas off of. They can provide a different perspective and tell you when you are making decisions based on emotion (even when you don’t want to hear it) rather than taking a rational approach. These are not always easy conversations to have and that’s why you will never have them with yourself.
More importantly a financial advisor will help you create a retirement plan (which includes your investment plan) that takes into account the unexpected, such as COVID-19, so you know what to do or you at least have a frame of reference to guide your decisions in times like these.
Whether you’re working with an advisor or you’re a committed DIYer, it’s time to revisit your asset allocation.
Asset allocation is the combination of different investment types that make up your portfolio. Most people’s asset allocations consist of some mix of stocks, bonds, and cash.
Your asset allocation will drive the majority of your long-term returns. It’ll also be the primary determinant of your portfolio’s volatility — aka your portfolio’s risk.
For example, a younger investor has a longer time horizon, meaning they have more time before they need their investments in retirement. They may be okay with weighing their allocation fully towards stocks because they can afford the greater market ups and downs to reap the greater rewards.
As you approach retirement, however, you will need to think about where you will be taking income from within your portfolio. Without knowing your unique situation, we would generally start to create separate buckets for your portfolio as you near retirement. One to make sure you continue to grow and keep up with inflation. Another with safe, low risk investments for you to make withdrawals from, which you will use to create income. It is important this second bucket protects your investments because there is not time for a recovery here when you start taking income. The key is to have enough income protected in this safe bucket that you can let your bucket of growth investments recover before you ever need them following times like we have experienced in early 2020.
If you panicked and sold all of your investments, your asset allocation was likely too aggressive, or you didn’t have a retirement income plan to clearly guide your decisions during times like these. Your first step moving forward should be to understand the potential risk of different asset allocations and choose one that you can stick with. It should also fit within the framework of a larger financial plan. After all, even the best investment strategy will not work if you cannot stay with it.
Once you have chosen an asset allocation, you’re comfortable with, you’ll need to decide how you’ll get back into the market.
Dollar Cost Averaging
All of the data would suggest that the sooner you get in, the better because the market always has a positive expected return.
However, if you did panic, we can assume that your risk tolerance is not exceptionally high. Thus, we want to avoid any other situation where you feel like you’ve made a mistake and need to get out.
We’d typically recommend a dollar-cost average strategy to investors with plenty of cash. Dollar-cost averaging means investing a fixed, predetermined amount over multiple intervals, instead of putting all of your money into your desired asset allocation at once.
This allows you to systematically enter the market while managing risk.
In practice, you may miss out on some market upswings by sticking to a fixed amount and schedule. However, you’ll also minimize the possibility of a drop occurring right after you invest.
For example, say you have $300,000 to invest. You decide to dollar cost average into your target portfolio (your intended asset allocation) over 6 months. You could start moving $50,000 per month from cash to your intended asset allocation (6 months X $50,000 = $300,000). Let’s say, after two months, your target portfolio drops 20%. But you stay the course and despite your losses in the first two months, you continue pouring $50,000 per month into your target portfolio. You’re now buying at a 20% discount from where you started.
You’re able to slowly enter the market without watching your entire investment plummet again.
And, as I previously mentioned, the market essentially always has a positive expected return in the long run. Keep up the steady dollar-cost averaging, and you’ll watch your returns climb when the market recovers again.
An alternative but related option to dollar cost averaging, is known as a glidepath. This can be used when getting into the market or just when getting your portfolio ready for retirement.
I mentioned earlier that we often have two buckets of money when it comes to retirement planning. Your safe bucket with low-risk investments for income and your growth bucket to keep ahead of inflation.
Generally, you would look to protect a minimum number of years’ worth of income. For example, let’s say you are planning to make $40,000 of annual withdrawals from your investments to create retirement income. Your plan may call to protect 6 or 7 years of income in the safe bucket ($240,000-$280,000).
The way we would manage the buckets over time to balance your growth, but also protect your income is to move money from the growth bucket to the safe bucket when the growth bucket has had a positive return, in order to replace the income withdrawn from the safe bucket (this is called rebalancing). Therefore, always maintaining a base amount in your safe bucket.
A glidepath can lower your risk in the earlier years of either retirement or getting back into the market (if you have recently panicked and withdrawn).
The way it works is starting you off with a more conservative asset allocation than your long-term target. Using the example above, if your target in the safe bucket is to protect 6-7 years of withdrawals/income. Using the glidepath strategy you may start with a higher allocation to your safe bucket, maybe protecting 10-12 years of income for example. Then, rather than rebalancing from your growth bucket to maintain the large safe bucket, you could just let the growth bucket continue to remain fully invested until you have drawn your safe bucket down to the target of 6-7 years’ worth of withdrawals/income.
Depending how much you start with in your safe bucket, this could take about 5 years before you do any rebalancing. This gives you much more time to weather any significant market crash and makes it much easier to stick with your plan and remain invested.
The whole point of investing should be to help you meet your goals, and the most critical part of a successful investment experience is having a plan you can stick with. Click here to see our process for helping people formulate a plan.
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This publication contains opinions of the writer and may not reflect opinions of Manulife Securities Investment Services Inc. The information contained herein was obtained from sources believed to be reliable, but no representation, or warranty, express or implied, is made by the writer or Manulife Securities Investment Services Inc. or any other person as to its accuracy, completeness or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any of the securities. The securities discussed in this publication may not be eligible for sale in some jurisdictions. If you are not a Canadian resident, this report should not have been delivered to you. This publication is not meant to provide legal or account advice. As each situation is different you should consult your own professional Advisors for advice based on your specific circumstances.This publication contains opinions of the writer and may not reflect opinions of Manulife Securities Investment Services Inc. The information contained herein was obtained from sources believed to be reliable, but no representation, or warranty, express or implied, is made by the writer or Manulife Securities Investment Services Inc. or any other person as to its accuracy, completeness or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any of the securities.