Many investors today are grappling with the sudden and shocking downfall of their investment portfolios. Just a few weeks ago the financial headlines continued to inform the public of the record highs that various indexes were reaching almost daily. How quickly things have changed. Today, the capital markets continue to reel from the economic impact of the Coronavirus. The two most burning questions investors have are:
1) How long will this last? Or more specifically for the investor, the question is how long will it take for the markets to recover?
2) How much value will I lose?
Although these two questions are important to address, nobody knows the answers due to the tremendous uncertainty – especially in the very short-term. Therefore, I believe the critical question an investor should ask themselves during this dizzying time is "How long is my investment time horizon?”
Your investment time horizon is the amount of time that you expect, in some degree, to participate in the capital markets (invested in either Cd's, annuities, stocks, bonds, real estate trusts, commodities, etc) – assets that historically have earned returns above the guaranteed rate of a 30-day U.S. Government no -default Treasury Bill. The allocation to the higher-yielding assets should typically decline the older you become. For instance, a 60 year-old would reasonably have a twenty-year time horizon with some level of capital market risk. The time horizon is an important element in constructing a financial plan as it will help identify the required risk tolerance needed to help make financial decisions in areas ranging from investments, taxes, and estate planning.
Linda, age 63 is going to retire at her full retirement age of 66. She expects to live off her social security benefits, savings, and other sources of income (i.e., rental income) until she reaches 72, which is when she will be required to take her Required Minimum Distributions. Because Linda has other retirement income sources, she doesn't plan on taking greater RMD amounts when she turns 72 and in fact, would like to preserve the IRA for her children to inherit. In this case, Linda may have a longer investment time horizon than Steven, for example who is also 60. Steven however, is greatly depending on his retirement accounts to maintain living expenses. He is thinking about delaying retirement until age 70 (but taking social security at age 66) to allow his lower amount of retirement assets to grow before he has to make withdrawals. His plan is to begin withdrawals from his retirement accounts at age 70 and they will be larger than his minimum amount at age 72. In this case, it appears Steven has a much lower investment time horizon and faces the potential risk of not fully recovering large short-term declines in his portfolio.
To maintain the required discipline to weather short-term market declines (like the one we’re in now). Focusing on the market’s long-term results allows us to see in hindsight the futility of reacting to large or small changes in market prices.The critical factor for a disciplined investor is the length of time you plan on being invested - not necessarily the amount of short-term losses.
Below is a chart that illustrates the S&P’s 500 index growth from 1928 to 2020
(S&P 500 index represents approximately 80% of U.S. Stock Market)
Some conclusions that can be made from this chart:
a) The market has been on an upward trajectory with short abbreviated declines since the 1930's during the Great Depression.
b) Even the value of today’s battered S&P 500 index is 250% higher than the low-point of the index during the 2008 Great Recession.
c) The longer the time frame you choose anywhere on the graph, the clearer it becomes that over time the markets increase, despite the periodic declines.
The data below illustrates what occurred the following two years from the years in which the S&P 500 index suffered double-digit losses.
The data indicates that over 94 years,
• Only once (1930) did the index suffer losses for the following two years after experiencing a double-digit loss.
• Of the nine years that experienced double-digit losses, five of them rebounded with a much higher return the following year, while three rebounded with higher returns the second year, and one (1930) took 3 years to rebound.
Hopefully viewing this information will help relieve some of the inevitable stress from the relentless exposure to news sources, which at times can result in making ill-advised investment decisions. The data above would suggest, at least historically, that if you plan on being invested for at least the next 2 to 5 years, you have a greater chance of recovering any substantial losses incurred this year. The starting point in any investment plan is to determine what your objectives and goals are. Our role then is to help guide you through the uncertainties involved in the various financial, tax, and investment decisions. And as I’ve tried to stress in this blog, paying attention to your investment time horizon and risk tolerance will help create a well thought-out plan to help clients make better informed financial decisions.
If you would like help in identifying your investment time horizon and level of risk tolerance, please feel free to contact us to set up a no-charge initial consultation.
Please review our website for more information on the type of services that we have provided to the greater Tri-Valley area for the past 20 years.