It would be an understatement to say 2020 has been a turbulent year. The health of the economy and stock market is no exception. We have seen wild swings in the stock market from the lows in March to the rebound levels we are experiencing so far in June.
Retirement – Is It Even Possible?
It has truly been a mental test for many people to stay invested in the stock market during this time. There has been a lot of money made and a lot of money lost.
As always, this shows the importance of having a sound financial plan and sticking to the plan no matter what happens. Having a well-developed financial plan can take emotional decision making out of the investment process and let logical decision making prevail.
Logic, strategy, and perseverance will win in the long run. We will discuss some options to help you properly prepare for your future with a long-term approach. Simply put I will teach you how to weather any financial storm because you can bet there will probably be another one in your lifetime.
Identify Your Investment Personality
One of the first steps on the path to financial success is to identify what type of investor you are – as far as risk is concerned.
Generally, risk is broken down into three broad categories:
The vast majority of people I speak to will say they are conservative or moderate risk investors. Typically, aggressive investors tend to have a more “gambler style” approach to investing, which is not common among the majority of the investing population.
It is extremely important to be honest with yourself as to how you want to approach investing. If the thought of losing hard-earned money frightens you, then it is important to invest accordingly.
If you do not invest appropriately, you may prematurely give up on your plan if you begin to lose too much money or abandon ship if you do not see the returns you expected. Not being invested according to your risk tolerance will often lead to emotionally-based investing decisions that can really hurt you in the long run.
Rather, we want our investment decisions to be based on strategy, logic, and a well-configured plan.
Develop A Strategy According To Risk Tolerance
Once we have worked together to identify your investment style and risk tolerance, it is time to come up with a strategy to maximize return, protect your investments, and accumulate wealth.
I will focus mostly on strategies for conservative or moderate investors throughout this article since this is where the majority of the investing population lies as well as a large portion of my clientele base.
A Firm Investment Foundation
An easy way to think of the financial journey is to think of it as building a house. The first step is to identify any financial obligations, debts, and the needs of the investor’s dependents.
Once we determine this, we will make sure they have adequate life insurance to cover any expenses they may need or want to have covered so dependents will not be left without income or left responsible for any of the investor’s outstanding debts.
Much of today’s life insurance also includes something called living benefits, which a policyholder can use for healthcare expenses while they are still alive.
Investments are typically earmarked for retirement or some other specific need, so we do not want them to double as an emergency fund for healthcare, debts, or an unexpected death. Additionally, if investments are held within an IRS qualified plan, there are limitations on when these funds can be accessed.
Using Life Insurance To Your Advantage
I view life insurance as the foundation of the financial house for these reasons. This can be accomplished by using either whole or term life insurance. While not a traditional investment, life insurance provides an amount of financial protection for my clients and their families which would otherwise generally take decades to accumulate.
Simply put, should life insurance be needed, it provides an extremely high rate of return in comparison to the premium paid. This immediate and tax-free payout is often overlooked in many financial plans and can create a hardship for families should the primary income earner die.
Remember, a good financial plan is more than just stocks, bonds, or mutual funds. You need to make sure any possible situation is covered. You need to be working with a financial advisor that is a fee-based fiduciary, not a stockbroker. If you are unsure how to tell the difference, you can view my previous article, “Is Your “Financial Advisor” Actually an Advisor? Investment Advisor vs. Broker.”
Building The Financial Frame To Weather The Storm
When one of my clients has a stable foundation, we begin to look at various investment options after we have covered any possible setbacks. As mentioned, this article focuses primarily on conservative and moderate risk tolerance as the vast majority of people fall into these two categories.
I view these investments as the walls of the house. These investments need to be solid and consistent. These investments are generally comprised of low-fee, low-expense, well established mutual funds that have a solid history of stable returns.
These investments are chosen based on historical performance, future outlook, and several other factors. Often times, these can be but are not limited to index-based funds or funds which invest in well-established blue-chip companies.
These funds are often lower in volatility and are consistent in their returns when compared to riskier investments. Many of these funds include established dividend-paying companies that help provide a hedge against market downturns as well as added income to the investor.
Depending on the investor’s age I will also look at the suitability of bond funds and annuities in their portfolio. Again, the purpose of these “walls” is to create consistent and stable growth as well as a strong structure of the house.
Finishing Touches To Weather Any Financial Storm
Now that an investor has a stable foundation and solid walls for their financial house, we will now put on the final touches. I will then look at this as putting the roof and fixtures on the house. Even in a conservative or moderate risk portfolio is can be appropriate in some cases to put some more aggressive investments within a portfolio.
However, these riskier investments will comprise a much smaller amount of the portfolio. These investments can include small-cap mutual funds, mid-cap mutual funds, or foreign investment mutual funds. As the investments are mutual funds, this provides instant diversification as they will invest in many companies, which will minimize risk when compared to purchasing individual stocks or bonds.
Small-cap, mid-cap, or foreign investment mutual funds, however, will generally be more volatile to positive or negative movement. These investments will be more suitable for younger investors who have a long-time horizon to recover from a down market or financial crisis.
Unnecessary Risk Can Be A Wrecking Ball
Just to put things in perspective as to why we do not want to assume any unnecessary risk:
This chart shows the importance of being properly invested. For example, if your portfolio were to take on a 40% loss, you would need to have a 67% return the following year just to get back to your starting point before the loss.
What do you think the chances of that happening are? Not sure? Here is the probability:
As you can see, even within a 10-year time frame, you only have an 80.6% probability of recovering from a 50% loss. It is also worth noting that contrary to popular belief, if you take on a 50% loss, you must earn 100% to recover from that loss, not 50%.
A Wealthy Retirement Is Still Possible
I take this approach that I have laid out with many of my own clients because it is a simple to understand concept, and is also amazingly effective. By building a house with a solid foundation and solid walls, even if an economic storm strikes and rips the roof off our house, we are in a position where we can recover quickly and repair.
A destroyed roof can easily be replaced compared to having to rebuild an entire house. If you do not have a solid plan with proper investment choices in place should an economic crisis strike, you may have your entire house destroyed and may not be able to ever recover.
This is even more true if you only have a short time horizon to do so (i.e. you are within 10 years or less of retirement). With the proper planning, you can weather any financial storm and have minimal rebuilding afterward.
It is also important to pick the right builder for your house. If you choose to work with a financial professional, make sure that person has a fiduciary responsibility which means they obligated and required to put their clients’ needs first.
If you have questions or would like personalized advice in building your financial house, you can schedule a one-on-one call with Gary (who is an investment advisor/fiduciary) here: https://calendly.com/downes-dalessio/thin-line-financial