Supplemental Commentary / Outlook – April 3, 2020
“The Power of Preservation”
If I’m not mistaken, this is the first ever update we have written for an audience outside of our clients. I will go ahead and assume that those reading are mostly unfamiliar with our firm and our message. As such, I hope you will resist the temptation to read the title as an opportunistic advertising opportunity. Instead, I encourage you to go through our previous updates spanning the past several years – as much of what we will discuss in this piece is done in much greater detail there.
Over the past few years, we have found ourselves telling clients that we wished we could “get all investors in a room, for just 60 minutes”. The reasoning behind that statement is much too lengthy and detailed to properly express in just a few paragraphs. In short, it was becoming clear to us that many investors were likely assuming risk with their investments that they may not understand – or worse yet – couldn’t really afford. The problem, as always, is that we often don’t realize these risks before it’s too late – and that is the main purpose of this update today.
It should be noted that this letter will apply most significantly to those at or near retirement. The message can certainly apply to younger investors as well, but they often have time and capital to recover that those nearing or in retirement do not.
I could probably summarize by using one simple phrase – one that happens to be plastered on virtually every investment piece you will read. “Past performance is no guarantee of future results”. I’m guessing most everyone reading this has seen it before. I’m also guessing the majority of you agree with the statement. If not, you should. But the question really boils down to this - are we actually taking that disclaimer to heart?
Hopefully, everyone reading this has done some level of financial planning - mapping out how you plan to achieve your short and long-term financial goals and needs. Assuming you have done so, what rates of returns for your assets did you use as an assumption? 7%? Maybe 8 or 9%? If so, why? Usually, we see those numbers thrown around based on “the average annual return of a given allocation over time”. In other words, “use past performance as a basis for future results”. There are a multitude of reasons we could give as to why those past returns may be unrealistic for the foreseeable future – not the least of which being 10-year treasury rates at a whopping 0.6% as of this writing – but we will leave it there for now. Point being, we have to be realistic with our assumptions.
Next, have you truly examined your own personal tolerance for risk? We like to look at “risk tolerance” in two different ways. First, is how much actual downside – carefully considering the timing of said downside – can your financial plan afford? Second, and equally important - how much “financial pain” can your emotions absorb at any given time? The answers to both of these questions are critically important. Failing to address them ahead of time is one of the best ways to destroy one’s financial future.
Now, let’s examine the most criminally under-discussed topic of wealth preservation – our discipline. The “fear of missing out” – otherwise known as “FOMO” to the Twitter generations. This is a tough one, and one you will most likely (and hopefully) end up facing much more often in your investment lifetime. FOMO sets in when markets are ripping, and your buddies are bragging about the returns in their 401ks. Turn on the TV, and every other segment is talking about “new, all-time highs for the markets”. It becomes really difficult to stomach those minimal returns on your more “responsible” portfolio during periods like this. But getting over that “fear of missing out” is one of the most critical ways to avoid assuming risk that you or your long-term plan can’t ultimately afford.
Which leads us to the most important thing to know about managing portfolio risk – it has to be done ahead of time, and be monitored constantly. We tell clients that our job is to help ensure that they will not outlive their money. Our clients have never heard that our job is to outperform the S&P 500 – or any other index for that matter. They never will. We work tirelessly to understand both the risks and opportunities that present themselves as markets evolve. At the moment, maybe even more so than other times, there seem to be plenty of both developing.
Now, the million dollar question that everyone wants answered is – where do we stand today? I wish I or anyone else could give you that answer. On one hand, I could make the case that the Fed has once again intervened with their manipulation of asset prices (which they certainly have) – though this time on steroids. As life returns to normal, as we believe it will, asset prices may follow the Fed’s lead and begin recovering quickly. In other words, “the bottom might already be in” – as many of the pundits on TV will say at nausea.
If this end up being the case, and it might, there is still time for those who may be realizing over the last few weeks that they have assumed more risk than initially thought or desired. If we have in fact bottomed out in the short-term, it is our belief that the majority of structural risks will remain. In fact, redundantly due mainly to the Fed, the risks may be even greater going forward. I would again refer to our previous updates on the site for more detailed explanations of our thoughts on the topic.
On the other hand, there remains the very real possibility that we have not yet seen the worst-case play out. Remember, the last two significant recessions / market sell-offs saw 50%+ peak-to-trough declines in the S&P 500. We are not there yet. Importantly, we must also note that the Fed had over 500 basis points (5%) of rates to cut in dealing with the last two – while we are already at 0% Fed funds rate along with QE “plus” only two weeks into the current crisis. In other words, the Fed is rapidly running out of bullets, assuming they are not empty already.
This may sound strange to hear, but those who have properly assessed their portfolio risk ahead of time should be hoping for the latter. I know we are. Letting the markets finally run their course without artificial Fed manipulation will leave a much “healthier” environment going forward. Actual “price discovery” of assets will occur, and value will present itself accordingly. Conversely, if the Fed is successful in manipulating out of this, investors will once again be left playing Russian Roulette with their holdings – never quite knowing just how over-valued assets might be in the absence of continued or further Fed intervention. It’s an exhausting and often dangerous exercise – putting retired investors in particular peril. Especially when interest rates on more conservative investments are virtually non-existent.
Conversely, those who have not sufficiently monitored risk beforehand will be left with the unenviable position of hoping the markets and economy will recover “in time”. This is where the significant difference between younger investors and those at or near retirement really present themselves. Younger investors not only have time to wait out the eventual recovery, but they are often adding to their positions along the way – taking advantage of more attractive prices on the way down. Retired investors, on the other hand, do not have either the time or capital to do so in many cases.
It is not an easy task to verbalize all of this properly, in a concise manner, and with the limited time I currently have at my disposal. But I hope that anyone reading this has come away with at least some additional perspective on the importance of risk management – or “preservation” - as part of one’s overall strategy. The good news is that, as with any type of planning, it’s never too late to start…
I will close with a quote we use often with clients, as I believe it to be important to consider in any type of market environment:
“Missing out on returns is frustrating, while chasing those returns can prove devastating.”
I again invite you to browse our “blog” section for more detail on many of the items discussed here – every update we have ever written is on there. If you would like to talk through anything discussed – or any other matter - please don’t hesitate to reach out. All of our contact information is there on the website (www.roundhillwealth.com).
As I am sure you will understand and appreciate, we are currently devoting all of our time and energy during market hours toward existing clients and managing their portfolios. But we will do our very best to return any calls or emails the day they are received, but after the markets have closed and communications with clients have been completed.
Thank you for taking the time to read this update, and we wish you and your families the best as you navigate through these difficult times.
Douglas Brymer David Swanson
President & Wealth Advisor Principal & Wealth Advisor
The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Statements of forecast are for informational purposes and are not guaranteed to occur. Trends discussed are not guaranteed to continue in the future.
All performance referenced is historical and is no guarantee of future results. Investments mentioned may not be suitable for all investors.
Equity investing involves risk, including loss of principal. No strategy – including tactical allocation strategies - assures success or protects against loss.
Value investments can perform differently from the market as a whole. They can remain undervalued by the market for long periods of time. There is no guarantee that any investment will return to former valuation levels.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
Government bonds and Treasury bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value.
Securities offered through LPL Financial. Member FINRA/SIPC. Investment advice offered through HighPoint Advisor Group, LLC, a registered investment advisor. HighPoint Advisor Group, LLC and Round Hill Wealth Management are separate entities from LPL Financial.