561.998.9985If you have been paying attention to your investment accounts, you may have noticed that the stock market has fallen dramatically this quarter. The S&P 500 closed at 2,924 on Oct. 1, and by Christmas it was down to 2,351. This represents an almost 20 percent decrease. Consequently, the value of your investments likely significantly decreased. For many, this can be very distressful.
If you were planning on selling your investments in the short term to raise capital for living expenses or some other purpose, this bear market (defined as a drop of at least 20 percent) has probably cost you a lot of money. This is exactly why we recommend our clients do not risk capital they need in the short term.
However, if you were still planning on owning stocks and other equity-based investments in five or 10 years from now, you probably won’t even remember this most recent downward move in stock prices. Does anyone out there remember the last time the market fell 20 percent?
If you had to guess you would probably say in 2008 during the last big recession. In fact, by Jan. 31, 2012, the S&P 500 had fallen almost 20 percent from its previous high. However, following hitting the low point on that date, the index fully recovered to its previous high in just 24 days.
Since 2009, there have been 14 market drops of at least 5 percent and the average recovery time to make a new high has been only 55 days.* If you have been sitting on a large pile of cash waiting for a big correction to create an attractive buying opportunity, stocks are now a lot cheaper than they were at the beginning of the quarter. However, in order to successfully execute this strategy, the cash must be deployed before stocks make another new high.
Please consult with an experienced adviser prior to making investment decisions.
*Fidelity Active Investor
For many years, clients stopped asking how much they would earn on their money market accounts because for quite a while, money market accounts weren’t paying any interest at all. However, with the Federal Reserve raising interest rates over the past year, our clients can now earn north of 2 percent on their money market accounts.
While it’s great to earn a little bit of interest on your short-term cash reserves, it’s still not wise to park excess funds in cash for extended periods of time, because even at 2 percent interest your money is still losing buying power over time due to inflation. Even for conservative investors, it’s not ideal to avoid investment risk only to be clobbered by inflation risk and longevity risk.
One of our favorite strategies for conservative investors who don’t want market risk or interest rate risk are liquid modified endowment contracts. These vehicles, which are issued by insurance companies, typically grow between 4 percent and 5 percent per year. The full account value is accessible at all times and no tax is due unless the gains are withdrawn. Additionally, these contracts provide a substantial tax-free death benefit for one’s heirs and can also can potentially provide a tax-free, long-term care benefit as well.
This is important because for many people who are still in good health, a substantial long-term care expense is the one thing that could derail their financial plan. Modified endowment contracts have a beneficiary designation that will avoid probate, and under Florida law these accounts are exempt from claims of creditors. So, while it’s nice to make interest again in the bank or a brokerage account, other safer alternatives exist that not only have much higher expected growth potential but significant tax, retirement, health care, and estate planning benefits as well.
The last quarter of 2018 has been very volatile for stocks, compared to the last several years of relative calm. This has made many investors nervous and potentially caused them to rethink their investment strategy. However, any investor who is surprised by recent volatility doesn’t really understand the historical movement of stock markets.
It would be great if we could all just sell our investments before major downturns and buy them back for a cheaper price than we sold them. However, no one is able to do that on a consistent basis. Luckily the market has always recovered from downturns.
Since 1900, the Dow Jones Industrial Average has dipped at least 10 percent on average about once a year, and 20 percent or more about every 3.75 years. Although the market has always recovered, many investors have consistently failed to participate in the recovery because they tend to reduce exposure to stocks after major downturns when the markets get too volatile. Since 1929 declines of at least 15 percent of the Standard & Poor’s 500 Index has been followed by a recovery that averaged almost 55 percent in the year following the major downturn.*
Therefore, it’s imperative that investors understand and expect their investments to have bad months or even bad years so that they will remain invested. The volatility is the price investors must pay to achieve stock market returns. Educated investors who expect the inevitable volatility will probably be more likely to resist the impulse to sell after a market pull back. In fact, since the data is undisputed that the average retail investor continuously under-performs the stock market due to selling stocks after downturns and buying stocks after rallies, it would be logical to conclude that it’s probably better to increase stock exposure after downturns. Even if the market doesn’t rally and recover as soon as we would like it to, if history is any indicator, stocks eventually will make new highs.
*American Funds
For most people who spend a lifetime prudently managing their wealth and their spending habits, the thought of their children recklessly and rapidly blowing their inheritance is disconcerting. According to a study by the National Endowment for Financial Education, 70 percent of all people who suddenly receive a large sum of money will use it all within a few years. According to behavioral scientists, although people tend to be frugal with money that is earmarked for a specific purpose such as a child’s education, they are much more reckless with unexpected windfalls like an inheritance or lottery winnings.
As a parent, you probably already have a good idea if your children are likely to be responsible with the money they inherit from you. If your heirs have built up a considerable net worth on their own, you are probably not too worried about them. However, if your grown kids are still coming to you for financial support, there may be an issue.
One way to prevent your kids from blowing their inheritance is to create a trust for them that appoints an independent trustee to help them manage their finances. Your kids can typically receive all the income generated by their inheritance each year, but they can only access the principal for specific purposes such as health care, education or emergency situations.
You can choose to direct the trustee to distribute some or all of the assets to your children once they reach a certain age. However, I usually don’t recommend this because if you are concerned about your kids blowing their inheritance, why allow them to blow it once they reach a certain age? As for annuities and IRAs, if you are trying to prevent your children from squandering those assets, you can name your trust as the beneficiary for those accounts. However, there may be some adverse tax consequences for naming your trust as the beneficiary of those assets, so you should consult with your tax adviser prior to doing so.
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