Looking back over a tumultuous year, we learned the value of
cool heads and steady hands. After dealing with the ups and downs of the
pandemic, the economy, the election and political and civil unrest, I marked
some broader lessons we can glean and implement in our financial planning for
2021.
Here are the four biggest lessons I’m taking to heart and
imparting to my clients.
1. Stick to the Plan
An effectively designed personal investment plan should meet
the investor’s goals, regardless of market fluctuations, over the short-,
intermediate-, and long-term. Of course, 2020 brought some of the craziest
market fluctuations we’ve ever seen.
The S&P 500 lost 34 percent of its value between
February 19 and March 23—then recovered completely by August 18. Investors who
didn’t stick to their plan may have sold tanking stocks during the decline,
then bought them back after the recovery was underway, sacrificing a large
portion of their personal returns.
An investment plan that can weather all storms will almost always
include a mixture of stocks, bonds, and cash consistent with the investor’s
needs and investment risk tolerance. And in good markets—and bad—investors must
stick to that plan.
2. Plan for Emergencies
One of the tools that helps investor clients stick to their
financial plans during tough economic times is a healthy emergency savings
account. The tremendous volatility of stock and bond prices throughout 2020 has
caused many investors to wince, but those with emergency funds can afford to
keep their investments in place and refrain from selling at inopportune times.
They may have been penalized by market losses in the first
quarter but should have been rewarded with sizable gains in the second and
third quarters. Unfortunately, many investors too light on cash were forced to
liquidate stocks and bonds at temporarily depressed prices to meet current
expenses.
Those dollars were therefore unable to recover their value
as the markets rose after the market bottomed in late February. Hopefully,
those investors have now learned that the solution to this quandary is to
maintain an emergency fund of cash, money market funds, or CDs that remain out
of the markets at all times, so they aren’t forced to liquidate an investment
portfolio when values are down.
Alternatively, a home equity or a personal line of credit, already
in place and easily accessible, can serve as an emergency fund. Whatever tool
you use, having a liquid emergency fund will protect your long-term investment
plan even when times get tough.
3. Keep the Markets in Perspective
Remember that the markets are leading, not coincident or
lagging, indicators of the economy. When the stock market indexes began their
precipitous decline in February, the economy was still humming. Unemployment
was at a historically low rate of 3.5 percent, and U.S. inflation for the 12
months ending January 2020 was 2.5 percent. Logically, data like that should
support a rising, not falling, stock market. But investors looked at the rising
coronavirus positivity and death rates around the world, recognized the
probability that this pandemic would spread to the U.S. and began selling in
massive amounts, taking stock prices down.
Likewise, by the time the markets commenced their recovery
in March, investors had taken note of the tremendous amounts of fiscal stimulus
and monetary accommodation provided by national governments and central banks
around the world, and began to bid stock prices higher. This all took place
against a backdrop of large-scale economic shutdowns, a U.S. GDP decline of 5
percent in the first quarter, and a March 2020 U.S. unemployment rate of 4.5
percent.
In the following months, unemployment rose (going as high as
14.7 percent), GDP declines accelerated (to negative 31.5 percent in the second
quarter), and the inflation rate fell into negative territory. These are all
historic signs of a weak economy— yet many market indexes have reached all-time
highs.
Those highs were driven by investors’ belief that
coronavirus vaccines will be developed and safely administered globally, and
that further fiscal stimulus and accommodative monetary policy will continue to
flow into the global economy—even though these developments may not further
materialize until 2021. Thus, they have shrugged off the present high unemployment
and low inflation figures and are bidding stock prices higher according to
perceptions of future scientific and government responses to the current situation.
4. Don't Fight the Fed
One of the best lessons for investors in turbulent times is
to understand the measures the Federal Reserve took to combat the economic
challenges brought on by the coronavirus. The Fed initiated an accommodative
monetary policy by providing multiple lending facilities to its member banks to
make funds available to borrowers at attractive interest rates.
Then the Fed embarked on programs of purchasing financial
assets, known broadly as quantitative easing, therefore increasing demand—and
prices—for those assets. Finally, the Fed affirmatively modified its approach
to controlling inflation and signaled a willingness to let inflation rise
meaningfully higher than its 2 percent target, therefore implying that rates
will continue to remain low—perhaps for years.
All these actions have the cumulative effect of raising the
value of financial assets—despite the current economic environment, and
sometimes even if the near-term outlook shows no signs of improvement. To
investors, this is a signal to increase investment in otherwise risky financial
assets and is ultimately why many wise investors manage their portfolios around
the Fed’s policies.
Conclusion
It is the nature of financial markets to rise and fall,
sometimes dramatically and quickly, because their behavior reflects that of
humans. When events occur like the dot-com bubble bursting in the early 2000s,
the financial collapse that began in 2008 and most recently the coronavirus,
they interrupt our collective complacency and cause us to reexamine the tenets
of personal finance and investing.
I believe the key to surviving financial shocks like these
is to take the lessons above to heart, follow them, and manage your
expectations—that is, to keep your head when all about you are losing theirs.
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