By David R. Guttery, RFC, RFS, CAM
President, Keystone Financial Group-Trussville AL
Throughout the year, we’ve talked about the possibility of being in a recession, and strategies for investing consistently through a recession. In today’s article, I’m going to discuss why it is critically important to avoid the emotional roller coaster if financial planning efforts are to be successful.
As I have mentioned on several occasions, if I could offer one universal piece of advice to anyone reading this article, and pursuing long-term financial planning objectives, it would simply be to not quit during times such as these. There seems to be a mindset at times that discontinuing investments into qualified plans, or simply letting those deferrals accumulate in cash, makes for the better option when we have economic uncertainty, and market volatility. I strongly disagree with this view. What you do today, could have a measurable impact on where you arrive tomorrow. That doesn’t mean that the composition of your portfolio doesn’t change, of course it will as market factors change, and economic conditions change.
To illustrate this point, I am going to walk through this graphic, in three parts, and offer my thoughts about the emotional roller coaster that we must avoid as we try to bring long-term planning objectives to fruition.
You may recognize this graphic as being very similar to a depiction of the economic cycle that I have described before. One of the main roles that I have as a financial advisor is to remain dispassionately focused on the long-term objectives that we have codified within our plans, and in the process, help clients avoid this emotional roller coaster.
Let’s start on the far left. To set the stage, the economy is growing, markets are faring well, and each month when you receive statements, you are excited by the growth of your investments. This can cause you to metaphorically throw caution to the wind, and begin to assume risks that may be outside of the boundaries that we codified within planning objectives. After all, risk is always easy to assume when everything is going up, correct?
The irony though is that while you feel exuberant about your portfolio, we are nearing the point of maximum risk. During this part of the cycle, one of my main tasks is keeping clients oriented on the path that we have implemented for the achievement of long-term goals. We can inadvertently undermine that effort if we are not mindful of risk guardrails during periods of time such as this.
Now consider what I call the mid-cycle phase. I believe that we are experiencing this part of the cycle at the present time. To set the stage, we have begun to recognize red flags with regard to the economy, and the markets. Markets have begun to reprice risk in recognition of those red flags. We begin to see negative results to a small degree, but we are still exuberantly confident in the past performance of the portfolio.
First, we contend with the denial that market and economic environments are changing in a material way. Ultimately, that gives way to fear, and the thought of, “Well I hope that I was right in that assessment”. After more losses accumulate, we begin to desperately look for immediate solutions to stop the bleeding. That leads to trading that realizes losses that had previously existed on paper.
As the devaluation continues, we hit panic mode, and ultimately what we call capitulation. This is when an investor is just emotionally exhausted, and liquidates everything to cash because they may have remained with an investment strategy from which they should have exited long ago. Ironically, this is often the point in the cycle when we are very close to the point of maximum opportunity, or the bottom of a cycle in the market. I have said this on many occasions, and I will reiterate again here, that absolutely no one, regardless of how well-qualified, can accurately predict when the bottom of the market may occur. For this reason, you must constantly assess areas of market exposure, and limits of risk, relative to the goals that are being pursued.
Now, consider the far right of the graphic. I call this the late cycle phase. This is where, I believe, the greatest amount of risk is present as it pertains to achieving long-term goals. Many clinical studies have shown that psychologically, people are five times more likely to avoid pain, than to gravitate toward pleasure. This is why I believe the greatest amount of opportunity cost risk is present in this phase. The pleasure of positive returns is not strong enough to outweigh the pain of recognized losses, so at the worst possible time, investors who are in cash following capitulation, fail to do what they should do, at the correct time.
So again, to set the stage, we have watched our investments outperform our expectations, and then following denial, fear, and ultimately the capitulation that follows, we have locked-in losses, and just in advance of the point of maximum opportunity.
Now we begin to see markets begin to move on fundamental points of data. Markets began to rise, gradually, and such things as earnings, revenue, and macro-economic metrics once again seem to be driving market movements. You watch this from the sidelines, still sitting in cash, brooding over the large loss that you recently realized during the capitulation phase. As the market continues to climb, this gives way to apathy.
As the market continues to recover, optimism begins to take hold, and another 25% is allocated back into the market. Ultimately, investors begin to feel comfortable that the worst is behind us and plow the rest of the cash into previously invested positions. The problem is, at this point, we are nearing the point of maximum risk again, where the cycle repeats itself.
In closing, let me illustrate why it is important to maintain consistency through such periods of time for the achievement of long-term goals. I took an actual client’s plan, and turned it into a sample case for this example. I’m only going to demonstrate one slide from the client’s plan, and this is the Monte Carlo stress test of our assumptions. These clients are very young, in their early 30s, and we recently evaluated their plan for retirement, and implemented a strategy for the achievement of those goals.
This graphic depicts four confidence intervals, and reveals that this strategy has a very strong chance of producing the results for which we are planning. I made one change to the assumption reflected in this plan. I assumed, that rather than a consistent investment strategy, that this couple would discontinue making contributions to their qualified plans, for the next two years, in response to current market and economic volatility.
So, in conclusion, regardless of the period of time, or the state of the economy, the achievement of long-term goals is predicate on the consistency with which you meet the implementation of the strategy. The composition of the investment accounts will change to reflect current periods of time, but the approach, dedication, and commitment to the strategy should be unwavering. Even missing a few years, with the thought of letting a volatile period of time pass you by, can have a detrimental impact, 40 years down the road, on the potential success of long-term plans.
(*) David R. Guttery, RFC, RFS, CAM, is a financial advisor, and has been in practice for 31 years, and is the President of Keystone Financial Group in Trussville. David offers products and services using the following business names: Keystone Financial Group – insurance and financial services | Ameritas Investment Company, LLC (AIC), Member FINRA / SIPC – securities and investments | Ameritas Advisory Services – investment advisory services. AIC and AAS are not affiliated with Keystone Financial Group. Information provided is gathered from sources believed to be reliable; however, we cannot guarantee their accuracy. This information should not be interpreted as a recommendation to buy or sell any security. Past performance is not an indicator of future results.