Are you frustrated by the markets? We are too.
It has been a long time since anybody saw much growth in their portfolio. And there has been no place to hide. The markets have not been kind to investors who have taken an active approach, and those who have been conservative have not fared much better.
This ‘no win’ environment has led to some big reactions.
In our industry, many advisors have taken a buy-and-hold approach. They have instructed their clients to look at their finances with a long-term lens, to keep their eye on the prize–no matter how far out it might look–and to stay invested. Mathematically and historically speaking, this is good advice. However, when clients are coming to their advisors because the current environment is striking fear into their hearts, hearing ‘just wait it out’ is not all that helpful. In fact, it can sound pretty dismissive.
On the other end of the spectrum, many clients are capitulating. They are giving in to fear and cashing out of their investments. They are leaving their financial plan in the dust and scrambling to get into any investment that feels safer.
We are not here to say that either approach is right or wrong. What we are advocating for is better communication between advisors and investors.
If anxiety about your investments is keeping you up at night, the first step should always be to have an honest conversation with your advisor. Tell him how you are feeling and why. What is your worst case scenario? What would give you more peace of mind? And if your advisor says to ‘just wait it out’, he should be explaining why. What does the historical data say? Even more importantly, what does your financial plan say? Will cashing out or investing in something ‘safer’ get you closer to reaching your goals? Or will it knock you further off course?
Risk needs to be a big part of this conversation. What kind of risk are you willing to take on? What are the risks of making a change in your portfolio?
Let’s go back two years in time.
Investors who have held cash for the last two years are now better off than those who invested in the S&P 500. However, if you factor in the inflation rate over that time period, they have lost 5% each year in purchasing power. Losing that purchasing power is a big risk.
What about the investors who chose to hold GICs instead of cash? Two years ago, they could purchase 5 year GICs at a rate of about 3%. Those investors are now locked in to that rate for the next 5 years. That means they do not have access to their money to invest in other, potentially better opportunities for that entire period. This is what we call liquidity risk.
Fast forward to today. Investors can lock into a 5 year GIC for about 5.5%. But what happens when that investment matures in 5 years? What if we are experiencing a recession? What if interest rates have plummeted? If those investors have to reinvest the principal at less than 5%, they will experience what is called reinvestment risk.
One risk that rarely gets talked about is opportunity risk. And the reason why is because not everyone considers it a loss. How can you lose something you never had? But think of it this way. When you are retired, you need income today, but you could also potentially need income for the next 30 years. If you stay in cash, you may have the income you need today. However, by giving up opportunities to invest in the market in strategic ways, your portfolio will not grow and you may run out of money. You have essentially mortgaged your future to protect today.
When it comes down to it, investing is about so much more than the financial tools you choose. We are not here to convince you to stay in cash or invest in stocks or bonds. Investing should be about strategy. It should be about identifying your long-term goals and structuring your portfolio to help you achieve them. And it should be about having the discipline to stick to that strategy, even when you are tempted to react emotionally to what is happening around you. Strategy is what gives you the comfort of knowing that you have a plan for whatever comes your way.
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