It’s often been said that most investors look back on previous market crashes as an opportunity but look at current crashes as a threat. Why is this the case? We believe that investors typically get “tunnel vision” during a crash and lose sight of their long-term plan. The narrative of “this time it’s different” can be extraordinarily strong. That narrative is also understandable because the circumstances that cause the markets to drop are often quite different. Let’s look at the causes of the three major market crashes over the last 20 years:
• 2000-2002 — Tech Bubble Burst and Terrorism (9/11)
• 2007-2009 — Financial and Mortgage Crisis
• 2020-? — Virus Crisis
Wow! These are quite different causes, but what do all market crashes going back to the Great Depression have in common? The time period following the market bottom was a great time to be an investor. We do not believe in market timing, but we do believe investors need to have a way to deploy cash in a way that they are comfortable with implementing.
With that being said...What are we advising our clients with cash to do right now? (These strategies are for cash beyond the client’s needed liquidity plan, which we will also discuss later in this article.) Here are four basic approaches to consider:
• LUMP SUM — As of the time of this article (5/7), the S&P 500 is still 15% lower than its all-time highs. Long-term investors that can stomach the volatility are likely to be rewarded for this courage, even though we might not be out of the woods in the short term. Pro-Tip: Focus on the long term and ignore short-term fluctuations after purchase.
• DOLLAR COST AVERAGING — This is the process of setting aside an amount of cash and buying into the market systematically over a certain time period. This is usually a 6-12-month period. (It’s a way to acknowledge that perfectly timing the market is impossible, and that allocating purchases over time will decrease timing risk as well as eliminate the likelihood of an emotional decision). Pro-Tip: Pick a day of the month that you will make this purchase each month and automate if possible.
• PRICE TARGETS — This is a pre-set amount you plan to invest if the market (we use the S&P 500) hits a certain level. We can all agree that the further the market falls, the more upside portfolios have in the future. Previously, the market bottomed out between 2200 and 2300 in March of this year. We have no idea if the market will revisit this level or not, but setting a target like 2400 allows you to have a non-emotional game-plan if the markets give another buying opportunity. Setting these targets ahead of time is important, because if the markets drop again, it will make investing seem scary at the time; making the decision ahead of time allows for you to follow through. The only downside of this strategy is that if the target isn’t hit, the cash will not be deployed. Pro-Tip: Stick with the plan even if you are scared to follow through.
• COMBINATION OF ALL THREE — This is our favorite strategy. Here is an example of how it works:
- Client deposits $600k into portfolio:
- Lump Sum investments of $300k (50% of cash)
- Dollar Cost Average of $50k per month over six months
- Price Target of 2400 on S&P 500 (This means we complete the dollar cost average all at once if this price target is reached and if it isn’t, we just let the dollar cost average finish itself out)
Time will tell which strategy works best, but any one of these four strategies will work better than never investing at all. Here are the two traps that investors can find themselves in:
• Trap 1 — If the market drops: “I can’t get in because the market will keep dropping further and I want to wait till it is safe.”
• Trap 2 — If the market rebounds: “I missed the bottom and I can’t invest now because the market is too high.”
Both emotional traps keep investors from making the right long-term decision. It is critical to eliminate the fallacy that investors can permanently time the top or bottom. Long-term investors will be rewarded not because of their timing, but because of their patience as markets fluctuate.
Here is a great summary of how to make sense out of this article:
1. SET UP YOUR LIQUIDITY PLAN — This means setting aside your needed liquidity for the next five-plus years in cash and bonds. (If you are retired, this means your monthly income needs after Social Security and pensions multiplied by 12 and multiplied by 5 years-10 years. If you are a long way from retirement, this could mean a six-month emergency fund and other short-term goal needs in cash and bonds.)
2. DEPLOY EXCESS CASH — If you are sitting on cash beyond that amount, consider one of the four approaches above
3. DON’T WORRY ABOUT TRYING TO PERFECTLY TIME THE TOP OR BOTTOM — We will only know the exact top or bottom in hindsight.
4. STICK TO THE PLAN — It is important to keep emotions at bay.
5. ENJOY YOUR LIFE AND TURN OFF THE TV — The whole point in having a plan is that it allows you to have a logical and non-emotional approach to your money, which frees you up to focus on the things in life that matter more than money.
If you want help during this crisis and don’t want to implement these strategies on your own or don’t have an advisor you love, we’d love to help. You can reach our team at LIVEWELL-CAPITAL@nm.com or 513.366.3664.
All investments carry risk, including potential loss of principal. No investment strategy can guarantee a profit or protect against loss in a down market.
Joseph B Beshear uses Beshear Financial as a marketing name for doing business as representatives of Northwestern Mutual. Beshear Financial is not a registered investment adviser, broker-dealer, insurance agency or federal savings bank. Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) and its subsidiaries. Northwestern Mutual Investment Services, LLC (NMIS) (securities), a subsidiary of NM, registered investment adviser, broker-dealer and member FINRA and SIPC. Joseph B Beshear is an Insurance Agent of NM and Registered Representative of NMIS. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNERTM CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.