by Jeff Deiss
CFP, AEP, Wealth Advisor
The answer to the question, “where is the stock market headed over the next three months?”, is on everyone’s mind and remains unknown. Much depends, as we’ve been describing for the past two weeks, on how quickly we all shut down our activity in order to stop the spread of COVID-19.
Testing is increasing, creating distressing headlines about the rise in new cases, but this is exactly what we’ve been expecting. Testing needs to soar and cases may peak in the weeks soon after everyone shuts down. Hospitals are already overwhelmed as expected. Economic activity is crashing as expected.
What can we do about all of this? First, stay home. This is the best thing to do to stay healthy, help us all get through this and for your portfolio to recover. Second, keep your long term goals in mind and stick to your plan. Market volatility is normal so don’t let it derail you.
If you’ve been through a cash flow projection or a related planning exercise with ACM already, then you know that we have to make an assumption about the long term rate of growth that your portfolio, depending on its allocation to stock and bonds, will achieve. This helps to determine how to invest your funds for the long run to satisfy your portfolio “withdrawal rate”.
I like to use the “worst 30-year annualized return” for projection purposes, which are significantly worse than the historical “average returns” in order to be conservative when planning.1
We also point out that these averages include all of the great “up years” like 2017 as well as all of the horrible down years, like 2008. We can’t include 2020 yet because none of us yet know how it will turn out, which reinforces the fact that you can’t plan for the long term based on what’s happening now or based on what’s happened in the market so far this year.
During the type of volatility, we’re experiencing, investors typically go through phases of “the worst must be over” to “this is worse than anyone could have imagined” to “this is hopeless and will never end”.
I don’t know exactly where we are, but I do know that the world is not coming to an end, the stock market is not going to zero and commerce never completely stops.
“In the middle of difficulty lies opportunity.”
Perhaps a better question to ask yourself today is “will the stock market be higher than it is today a year from now?”. I think a lot of us are still confident that it will be and, as a result, many of us will eventually be looking back on the current crisis in hindsight as an opportunity, much like you can look back at any previous crisis that has happened.
Given that periods of uncertainty like today can create inertia, here are some opportunities that exist today:
Diversify your concentrated position –We wrote in “Dealing with unrealized capital gains” that the actual value of deferring gains is less than most of us expect and that gains can quickly be wiped out. Many investors remained paralyzed about what to do as a result of the tax implications of diversifying. If you are one of them, then now’s your chance. There are lots of other goodcompanies with bright futures that will be around long after this crisis is over. They won’t all perform like the one(s) you already own, but that’s precisely the goal of diversifying.
If, on the other hand, you sit and wait to recoup the gains you’ve lost in what you already own, then you’re going to put yourself right back into the same “I don’t know what to do because of the taxes” dilemma.
Roth IRA Conversions – We’ve also described Roth IRAs and folks who’ve done planning with us understand that they can be valuable sources of retirement income and/or for legacy purposes when compared to traditional IRAs.
You can convert any portion of your traditional IRA to a Roth, which is a taxable event and the amount that you convert is considered taxable income. The resulting amount in the Roth will grow tax-free and you can make future withdrawals from it tax-free as long as you meet certain qualifications.
The conventional wisdom is to defer taxes in an IRA for as long as possible and withdraw funds from them later in life when you are in a lower tax bracket. For many retirees, however, a lower tax bracket never comes, which makes a Roth IRA more valuable.
If you were planning on a Roth conversion, then don’t let the current volatility derail you. Given that you have to pay income taxes based on the value that you convert, it’s reasonable to do so when the value you are converting is lower.
Get Invested – The opposite dilemma from the folks with large unrealized gains are the folks who have remained on the sidelines with cash throughout the bull market. If you’ve been waiting for the “bubble to burst” before you get in, then the current crisis provides an opportunity. With few exceptions (having a generous pension, significant real estate holdings, or a trust fund), you’re unlikely to meet your long term goals without investing in stocks and bonds, that are needed provide growth and income, over the course of 20-40 year retirement. You’re not investing today for the next three months, but rather for the next five or ten or thirty years. And it’s significantly cheaper to do so today than it was a month ago.
For folks who are still saving and accumulating, then continue to invest. Dollar-cost-averaging means that you’re adding to your portfolio during the highs and the lows.
Lastly, for those investors who already consider the current environment an opportunity (and, yes, there are as many of these as there are folks who are nervous), then my advice is don’t get cute. Don’t take funds out of your emergency fund or that you otherwise have earmarked for short-term expenses (house, car, tuition, wedding, vacation, etc.) and invest them. Only invest what you can plan on keeping invested for at least five years. And don’t expect to be able to time it perfectly.
“Staying Invested Matters”
You can find a synopsis of why we think so here. In the long run, bear markets are brief and bull markets are long.
1 Data source: Ibbotson Associates, 2018 (1926–2017). Past performance is no guarantee of future results. Returns include the reinvestment of dividends and other earnings. This chart is for illustrative purposes only and does not represent actual or implied performance of any investment option.
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