Develop an Individual Financial Plan That Accounts for Market Volatility
As we head into the final quarter of 2018, it is a great time to reflect on the financial markets. We have experienced the longest period of economic expansion in the nation’s history, and we have come a long way since the mortgage and housing crisis in 2008. However, as you may know from recent headlines, the fourth quarter got off to a rocky start. The Dow fell over 1,300 points earlier this month. Trade wars with China and increasing interest rates take most of the blame for increased volatility and recent drops, in spite of a strong economy and low unemployment.
AAFCPAs Wealth Management reminds clients that there are always going to be unanticipated events and headwinds that impact markets. No one can predict when the next sustained market downturn is coming. The only thing for certain is that markets go up and markets go down.
Lessons Learned
A recession, by definition, is when the gross domestic product (GDP) of the US Economy contracts over two consecutive quarters. Since the 1940s, we have had eleven recessions—some mild and some more severe—and there is no consistency to how they began. The reasons have ranged from War to Y2K, the Savings & Loan Crisis, aggressive monetary policy and, most recently, the mortgage and housing crisis. Similarly, there is no consistency to how long the periods of economic expansions have lasted between recessions.
The S&P 500 index, a broad indicator of the US stock market, closed at 1,565.15 on October 9th, 2007. It ended up dropping from that number to a close of 676.53 on March 9th, 2009. That is a 56.78% decline, peak to trough. For many, that was a gut-wrenching market contraction. However, if you stayed invested throughout the turbulence and rode the market back up, you are likely fully recovered and then some. For example, if you had invested in the S&P 500 the day before Lehman Brothers failed in September 2008, and you stayed invested even as the market began to crash, you would be up over 125% today!
AAFCPAs Wealth Management proactively plans for these market cycles. We start by developing a written financial plan for each client’s short, intermediate, and long-term goals. Our goal is to ensure assets are invested in a way that allows clients to accomplish their goals without taking too much risk through all market cycles. We will not recommend a strategy that has too much risk, too little risk, or one that jumps in and out of the markets in response to market cycles. We address risk by diversifying portfolios into investments that are uncorrelated, with the intention that they will not all rise and fall together. With this type of diversified approach, it is natural that over time, some asset classes will become over-weighted and some will become underweighted. As needed then, we rebalance accounts back to their intended allocation, derived from each client’s individual plan. This can help smooth out the ride during volatile times, and allows for more predictable levels of performance.
Who is Monte Carlo?
It is impossible to know how markets will perform over any reasonable finite periods. AAFCPAs Wealth Management uses Monte Carlo simulations to arrive at our clients’ planning results, particularly around retirement goals. Monte Carlo is a mathematical calculation that statistically simulates the volatility of the financial markets over your life expectancy for the asset classes included in your personal retirement plan. The analysis uses a large number (1,000) of statistical projections of market performance to predict three main possible future financial outcomes: best case scenario (top 2.5% of results), average case scenario (50% of outcomes), and down case scenario (bottom 2.5% of results). These real-world outputs are based on your family history of longevity, and take into account your guaranteed retirement income, your tax situation, your investment risk, your investment mix, your expenses, and other inputs.
Recession or not, volatility is a part of investing and the best way of addressing this is to build a plan that accounts for this uncertainty.
AAFCPAs Wealth Management solutions are designed to assist clients in reaching short and long-term personal financial goals, while controlling risks. And our mission is to provide valuable peace of mind to those who share the awesome responsibility to manage wealth.
If you have any questions about your personal financial plan, please contact: Andrew E. Hammond, CFP® at 774.512.4143, ahammond@nullwealth.aafcpa.com, or your AAFCPAs Wealth Advisor.
AAF Wealth Management is a Registered Investment Adviser. Advisory services are only offered to clients or prospective clients where AAF Wealth Management and its representatives are properly licensed or exempt from licensure. This blog is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by AAF Wealth Management unless a client service agreement is in place.
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