Fear sells. That’s no secret. When you look at news headlines, how often are they positive? This is especially true in today’s climate with non-stop riots, protests, and what seems like daily police or civilian shootings.
When we are constantly bombarded with negativity, it is easy to forget about all the good. We can easily get caught up and begin to let the fear take control. We begin to see the worst in our neighbors, businesses, and even in ourselves.
After a while, you may begin to doubt the decisions you have made. This is equally true with your financial life. Constant headlines of soaring debt, delinquencies, bear markets, overpriced this, and overpriced that.
It is important to remember that the plan you developed previously (whether yesterday or 40 years ago), was implemented for a reason. Does this mean you shouldn’t change or adapt you plan? Absolutely not. However, it is important to make decisions that will not compromise our future goals.
In what follows, we want to remind everyone to stay the course. Do not get caught up in the headlines and the fear mongering. Have confidence in yourself, in your plan, and in those you work with, like us, your financial planners.
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Forget about Fear, Stay The Course
When you develop a comprehensive financial plan with your financial planning professional, it is important to actually follow your plan and stay the course in turbulent times.
When you go to the doctor he might say you need to take “X” medication. Now after 5 years of taking “X”, one day you feel a little ill. You aren’t going to just abandon “X” and assume the plan you and your doctor had agreed on was wrong or needs changing. So why would you do that with your financial plan?
Of course, financial plans need to be reviewed. Just like people need to go to the doctor or dentist for checkups. However, if it was a well-crafted plan that was designed to meet your goals, if there have been no material changes in your life or the products used in the plan, why would you change the plan?
A good financial plan should be all encompassing. It shouldn’t just deal with immediate needs or only one section of your financial life. A comprehensive plan looks at immediate needs, future needs, estate planning, tax planning, insurance needs, investment needs, etc. In the end anything that could have an affect on your financial well being should be considered.
The following are some points that are often overlooked.
Although most people maintain some form of an emergency fund, it is often insufficient. We often tend to overestimate our income security and underestimate our needs. The rule of thumb is to have 3-6 months of living expense on hand.
Although, for some people, that may seem excessive, we can assure you it is not. Furthermore, if the time comes where you need to access it, you will be glad you wont have to worry as much about pinching pennies.
You can read one of our previous articles for more information on Emergency Funds.
A large part of the importance of the emergency fund/cash reserve, is covering off unforeseen expenses. However, there are other means that work well in tandem with cash reserves.
Covering the Unforeseen
In some situations, there are more beneficial ways to cover off the unforeseen than accessing your emergency fund. These alternatives come in the way of insurance.
There are many different types of insurance available other than just life insurance. Disability insurance, critical illness insurance, third-party liability insurance, business overhead expense insurance, etc. If you can think of a need for insurance, there is almost definitely a product available.
In some circumstances, not all, insurance solutions play a key role. The basic concept of any insurance is; you pay a premium, and in turn, if a situation occurs where you incur a loss, you receive a lump sum of money.
Let’s look at disability insurance as an example. With disability insurance, either long or short-term, you are insuring that if you become disabled you will still have a source of income.
The premiums that you pay are based on multiple factors; age, gender, occupation, health status, income, coverage period, benefits. As long as you pay the premiums of the policy, and something happens where you meet the criteria to be considered disabled, the policy will now pay you.
A lot of times, insurance is seen as a waste. You a pay the premiums and you might never access the benefits. Although, this is true, think of it differently: you should be paying the premiums hoping that you never have to access the benefits. Is becoming disabled worth it just so you can access some extra money? Alternatively, if you do all of a sudden become disabled, the benefits are there.
Tax planning should always be top of mind. It should not, however, be done at the expense of other needs. The old saying “there are two certainties in life, death and taxes”, is true.
Although avoiding tax altogether is not possible, effective tax planning can save you a lot of money. It should be done with the big picture in mind; encompassing your needs, goals, and values.
There are four main tax planning techniques; Tax Deferral, Income Splitting, Tax-Favored Savings Vehicles, and Tax-Efficient Investing.
Tax Deferral means earning income now but paying tax on it in the future. The most common example of this would be the RRSP.
Income Splitting means earning a income but having another taxpayer pay the tax. Common examples of this is retired couples splitting pension income.
Tax-Favored Savings Vehicles is pretty easy to understand based on the name. Examples of this would be the RRSP, the TFSA, and the RESP.
Lastly, Tax-Efficient Investing means investing in a way where you are limiting your potential taxable exposure. This might mean investing in dividend paying investments, or investments that only generate a capital gain.
Proper diversification is often used as a concept applied to investing. Diversification means having a basket of several different securities instead of just one.
The price of any given security will respond to different market circumstances in dramatic fashion. A basket of securities will mitigate pricing fluctuations between themselves and have a more stable and predictable rate of return.
Although we aren’t addressing your investment portfolio here, the same concept carries over to how you manage your wealth. Proper diversification when it comes to your personal wealth would mean ensuring you’re not overly exposed to one particular asset class or savings vehicle.
For example, say you have accumulated a large amount of savings in RRSPs and your company pension. You still rent. The risk you bear is the potential for housing prices to rise, leaving you missing out on the tax free capital gain of your primary residence. You may want to consider diversifying into real estate and purchasing your own primary residence.
Proper diversification on the personal wealth front would have you with a reasonable chunk of equity in your primary residence, a good amount of savings in your RRSP/company pension, your TFSAs filled up, and perhaps a small portion of wealth stored in another asset not correlated to the real estate or investment market like jewelry, fine art, or collectibles.
For more on diversification, check out What is True Diversification
Historical Times of Fear (Bear Markets)
As an investor, when fear is in control of you, that is when the biggest slip ups happen. I’m sure we all know someone or have heard stories about someone entering a bear market and fear getting the best of them. They disregard long term goals, focus on potential short term losses, make unwise decisions to sell and sit on the sidelines, potentially setting them back years.
Often times, now that they have locked in those loses they are to skittish to redeploy their money. “It happened once, it will happen again”. However, in many of those instances, had those people been patient, trusted their plan to work, and stayed the course they would have come out ahead.
Lets look at a couple of examples:
Lets assume their are three different people; person A who was investing during the 1970’s, person B during the 1990’s, and person C during the 2000’s.
The recession in the 1970’s lasted one year and four months from November 1973 to March 1975. From March of 2001 to November of 2001, there was another recession totaling 8 months. Lastly, in December of 2007 there was a recession of 1 year and 6 months, ending in June 2009.
During the 1970’s stock market crash the Dow Jones had a peak to trough decline of 46%. During the early 2000 the peak to trough decline was 34%. Last, in the financial crisis, the peak to trough decline was 54%.
If someone had been holding index funds during these times, they would have experienced substantial declines. These declines caused a lot of people to let fear take control, causing them to sell and withdraw everything.
What would it have looked like if each of these individuals had exactly $100,000 prior to the crashes and stayed the course? Let’s find out.
In December of 1972 the Dow hit 1,020.02. Hitting the bottom in September of 1974 of 607.87. By March of 1976, most of the losses had be recouped. However, it wouldn’t surpass the 1972 highs until December of 1982.
Lets assume they held a Dow Jones index fund and at the end of 1972 is was worth $100,000. For the purpose of this we will not take fees, taxes, or inflation into account.
If they had withdrawn everything at the end of 1974 they would have been left with about $60,000. However, had they stayed invested they would have broke the $100,000 by the end of 1982.
That’s 10 years just to get back what you lost. However, in the following 18 years, that $100,000 would have grown to more than $1M in 2000. As of the time of writing, that original $100,000 would be worth nearly $2,750,000. That’s an average annual return of 8.39%
In December of 1999, the Dow hit a high 11,497.12. By September of 2002 it hit a low of 7,591.93. It would have taken until august of 2006 to recoup those losses and for the Dow to hit a new high.
Let’s use the same assumptions as above: $100,000 at the end of 1999, no fees, taxes or inflation.
If they had withdrawn everything at the end of 2002, they would be left with $72,500. However, had they stay invested, they would have ended off 2006 at more than $108,000.
Had they weathered the storm and stayed course, their original $100,000 would have grown to roughly $245,000 today. That is an average annual return of 5.45%
In October of 2007 the Dow hit 13,930.01. By February of 2009 it hit it’s low point of $7,062.93. It would have taken until February of 2013 for it to close out higher, 14,054.49.
Had Person C withdrawn everything at the end of 2008, they would have been left with $66,000. However, had they stay invested they would have ended 2013 with nearly $125,000.
Fast forward to today, that $100,000 at the end of 2008 would be worth more than $211,000. That is an average annualized return of 7.22%.
In the end, if you have a well developed comprehensive financial plan, stay the course. If you situation hasn’t changed and the contents of the plan haven’t changed, why would you change your plan. Said another way, if your travelling on a road towards a destination, and your destination is the same, and the quality of the road is the same, why would you take a detour?
For all three situation above, everyone who weathered the storm came out a head. Yes, pass events do not guarantee future results. However, a lot can be learned from the past. Sure if they each individual could have timed their buying and selling perfectly, the could have been even further ahead. Lets remember the advice of Nick Murray:
Timing the market is a fool’s game, whereas time in the market is your greatest natural advantageNick Murray