Has it only been a year? I know I’m not the only one asking the question. So much has already been said about the year 2020. The COVID-19 health crisis and the subsequent social and political unrest this past year have forced us all to adapt to an ever-changing environment. The disruptions have left many of us wondering whether life will ever return to “normal”. With emotions on edge and our trust waning, we turn the page on 2020 and look to a new year. How do we make sense of all of these changes? How do all these changes impact our investments and our confidence about retirement? As you review your investment accounts at the close of 2020, you may be thinking “Wow! I couldn’t have predicted stock prices and the stock market indexes to be at all-time highs after a year like last year.”
Leading up to mid-March 2020, many investors panicked about a further slide in stock prices, caused by an economic recession and serious concerns about a protracted recovery, leading to a potential economic depression. Unfortunately, some investors took action and sold stock, expecting the February and March 2020 stock market declines to continue. The S&P 500 index dropped 35.41% from a high of 3,393.52 on February 19, 2020 to 2,191.86 on March 23, 2020. Despite investors’ worst fears, the S&P 500 has since gained 74.59% to reach a new high of 3,826.69 on January 8, 2021.
Some important lessons can be learned from the unpredictable stock market results of 2020. Despite our worst fears and even in the midst of financial crisis, there is no way to predict short-term stock price movements. The market is constantly reevaluating stock prices based on expected future earnings. All publicly available information that may impact future earnings is immediately reflected in current stock prices. This makes predictive timing strategies extremely risky to long-term investment returns. Even if investors correctly time the sale of their stock investments before stock prices drop, they are left trying to predict if the timing is “right” to invest in stocks again. In response to the unknown outcome of any crisis, our fight-or-flight instincts scream at us to do something, whether it is to buy toilet paper or sell our stock investments.
The year 2020 has taught us that the time for action starts before we see the crisis approaching. Investing in the stock market should begin with a well-thought-out financial plan to ensure that such investments are part of a long-term strategy. Stock price declines lasting multiple years should be expected and incorporated into any long-term asset strategy. On average, one out of every four years will produce a negative stock market return. Thus, any money that an investor plans to spend over the next five years should not be invested in the stock market. Proactively selecting an appropriate long-term investment allocation of stocks can significantly help remove an emotional reactions to stock market declines.
When markets move significantly and our instincts compel us to do something, we should avoid making investment changes based on predictions about stock prices in the coming months or even in the coming years. Instead investors with a long-term plan and a target investment allocation can feel confident in rebalance their stock and bond investments back to predetermined targets. Investors should consider rebalancing their investment portfolios once a year at a minimum, whether stock prices rise or fall. Executing this predetermined action plan will systematically force investors to buy low and sell high in quantities that bring their portfolios back into balance with their intended target allocations.
This past year has reminded us that opportunities await the patient investor who understands market swings and has a long-term perspective. The pandemic and subsequent strife in 2020 have emphasized that not everyone loses during a crisis. In fact, every crisis creates winners and losers. Experienced, patient investors are not only ready to rebalance during market declines but also execute tax-saving strategies. The following are just a few tax strategies you may consider during significant economic and stock market declines:
- Harvesting tax losses in a taxable account that can be carried forward and used to offset future capital gains.
- Converting a portion of an IRA or 401(k) to a Roth account, while paying a reduced tax as a result of potentially lower stock market values or reduced annual income.
- Switching from traditional retirement contributions to Roth contributions because of reduced annual income.
As we look to 2021 and beyond, the disruption and fear caused by changes will be inevitable. You may be thinking “We are at all-time highs in the market. There has to be a correction coming.” When your brain screams at you that your market prediction has to be right and now is the time to do something, may I suggest that you take a lesson from 2020 and start this year with a well-thought-out, long-term financial plan that includes an appropriate target stock investment allocation? So, when stock prices decline—regardless of the timing—you will be ready to rebalance and execute tax-saving strategies to increase your long-term investment returns.
Aaron B. Sautter is a financial advisor with Onyx Financial Advisors, LLC, an independent, fee-only registered investment advisor firm located in Idaho Falls, Idaho. He can be reached at (208) 522-6400 or at www.OnyxFinancial.com. Published January 31, 2021 in the Post Register Financial Planning Insert.