Autumn… The Season of Second Chances
- Recent volatility has opened a window of opportunity to start reinvesting, in our view.
- Clear goals can help guide investment decisions.
- We believe the next significant pullback might come at a much higher price.
September and October have historically been some of the most difficult and volatile months for the stock market. For that reason, they can also be viewed as the months for ‘second chances.’ By ‘second chances’ we are referencing a potential opportunity window for investors to put money back to work (invested in the stock market), especially for those that have held excess cash throughout the strong rebound in stocks since March.
This year it appears that the window for second chances has arrived right on schedule. The US market has declined about 6% since its high on September 2nd and the decline in the technology-heavy NASDAQ has been even greater at about a 9% drawdown. We think this pullback creates a potential buying opportunity, but we do not know how long this window will remain open or how wide it will extend, particularly with the ongoing COVID-19 pandemic and the upcoming US presidential election. However, we believe that this window will eventually close as we get through this volatility ending this period of ‘second chances’. When it does, we think the secular bull market will continue to march on well beyond the election.
This week, we would like to offer our thoughts to anyone struggling with ideas for their excess cash. Additionally, we highlight our belief that a tailored financial plan can bring clarity to seemingly difficult investment decisions.
Investing Excess Cash: Clarify your Goals
“If you don’t know where you’re going, any road will take you there.” – George Harrison
Until you know the destination, it’s very difficult to get started on your journey. Thus, before deciding how to invest excess cash, we would argue the first step should be to identify a goal for the money. This is where a financial advisor can help you clarify your objectives and understand your risk tolerance.
A common destination (goal) for investing is growth, which is typically associated with longer time horizons, higher potential returns, but also more volatility along the way. Another goal for investing might be to generate a certain amount of income, to fund retirement, or to maintain a certain lifestyle. These goals will help guide investment decisions, making the emotional choices about market levels and timing decisions less significant, in our view.
Should I wait to get started?
We understand that investors are hesitant to buy stocks after such a sharp recovery. While investors often feel uncomfortable buying stocks at all-time highs, by definition a bull market is constantly making them. We think a new bull market began from the lows in March and that the recent breakout to new highs is a confirming signal of that view. Our Chart of the Week reminds us that while bear markets occur, stocks have historically continued to ultimately rise despite political and economic shocks. Waiting for the next pullback and trying to time the right entry point is difficult and not a good strategy in our view, especially since the next significant pullback might come at a much higher price level than today.
Chart of the Week: Equity Markets Have Endured Throughout History
We think the chart also highlights the benefits of dollar cost averaging, rather than market timing. Reluctant investors might consider regularly feeding cash into the market to provide a chance to buy at lower levels should they occur. This process also lowers the emotional impact of picking a specific day or week to get started. We wrote a more detailed piece for reinvestment plans in our April 13th Weekly View: Reinvesting in a Rising Market is Like Merging into Traffic.
For Investors focused on Growth:
There is an old Chinese proverb that goes something like this:
“The best time to plant a tree was 20 years ago. The second-best time is now.”
With a longer investment horizon, the importance of market timing decreases significantly, in our view. From this perspective, we believe long-term investors should be more troubled by missing market upside, than avoiding some temporary downside. While we believe stocks offer more growth potential than bonds over time, that growth comes with greater levels of risk and volatility, such as what we have experienced in the last few days.
For Investors focused on Income:
With historically low interest rates, there is a cost to holding cash. Money market instruments and certificates of deposit (CDs) are currently paying about 1% or less. With inflation around 1% (as measure by the Consumer Price Index), cash on the sidelines is not keeping pace with prices. Thus, we believe investors should weigh the risks of losing purchasing power against the risk of losing principal. The longer your timeframe, the more losing purchasing power becomes the greater risk, in our view.
In the past, retirees could rely on the fixed income portion of their account to generate enough income to meet their lifestyle needs. Today, we argue that stocks need to play a part in generating cashflow, whether through their dividends or capital appreciation. While fixed income won’t provide as much current income as was enjoyed by previous generations, we still believe bonds still play a valuable role in lowering overall portfolio volatility and reducing the magnitude of drawdowns when stocks are falling. For example, at the March 23rd low, the S&P 500 declined more than 30% on the year while bonds, as measured by the Bloomberg Barclays US Aggregate, gained 1%.
We believe the recent volatility has opened a window of opportunity for investors to confirm their portfolio aligns with their goals. For those that have stockpiled cash, we think the next couple months will offer a “second chance” to start investing again.
Fortunately, with the help of a financial advisor, an investment strategy can be tailored to the unique goals of the individual while properly balancing the relevant risks and rewards. A well-structured financial plan should incorporate the potential for corrections and bear markets and give you the confidence to start making your cash more productive.