Are we in an economic downturn? Certain signs point that way. As reported in September 2022, inflation was 8.3 percent on an annualized basis in August. That’s one of the highest rates in 40 years—and, following the report, the broad-based U.S. stock market indexes, such as the S&P 500, were down sharply and are down for the year through the end of the 3rd quarter of 2022.
Hiring remains robust in many sectors, but salaries have lagged inflation. Eventually, since inflation erodes purchasing power, the economy may experience some shortfalls in consumer spending and potentially business spending as well. So, a further slowdown is possible.
When the prospect of an economic downturn looms, it helps to have a sound plan in place to safeguard your financial assets. Here are crucial actions that affluent investors may think about taking ahead of and during an economic downturn in order to safeguard their assets.
This blog answers these questions:
It’s crucial that investors understand two things: First, investing in securities involves taking on risk. The idea that all risk can be avoided is a false hope. Second, economic downturns happen periodically in the U.S. (as well as globally), and some of them are severe. Proper portfolio planning should assume such downturns occur.
Stock markets commonly fall during economic downturns and may fall even at the prospect of one. Why? Because, over the long-term, stocks generally move based upon company profits. If corporate profits are constrained (or drop because of economic pullbacks), it will likely affect the stock market negatively. When economic times are good, profits climb—and the stock market is more likely to rise.
If that makes you tempted to avoid stocks, realize that other asset classes carry risk as well. Bonds are generally less risky than stocks. However, one of the primary risks that bond investors need to look out for is the possibility of rising interest rates. Bonds and interest rates move in an inverse relationship. When interest rates rise, as they have this year, bond prices generally drop.
Fortunately, in Houston, Texas, a Linscomb Wealth wealth advisor’s goal is to help you properly plan for this risk. Longer term, rising interest rates potentially can be good for bond investors, because they cause the yields on your bonds to rise. Purchasing bonds at a higher interest rate can be the way to go, but it’s also crucial to manage the risk of interest rates rising further.
Many investors view cash instruments, such as certificates of deposit, as risk-free (due to the fact that the risk to your capital is very low). And it is true that the principal in cash instruments rarely declines. In contrast, stock and bond prices can and do decline.
Regardless, high inflation, unfortunately, does end up posing a risk to your cash investments. Even the best interest rates on cash instruments rarely outpace inflation over time. At the recent levels of 8 percent-plus inflation, you are effectively losing 8 percent of your cash each year, in terms of purchasing power, if your money is in a non-interest-bearing bank account.
If you’re getting 2 percent to 3 percent interest on your cash instruments, you are still losing money for the difference in the inflation rate and your interest rate. These differing risk profiles of the major asset classes illustrate why investors commonly diversify their money among asset classes which include stocks, despite periodic, expected bear markets. Even with bear markets factored in, stocks are one of the few investments that can potentially, on average, keep investors ahead of inflation on a consistent basis.
Is there a magic formula? For investors, the “magic formula” is simply this: a well-thought-out asset allocation between cash, bonds, and stocks to diversify investments may reduce risk and improve overall portfolio performance. That asset allocation should take into account your goals, your age (since, for example, older people might need a heavier weight in investments that fluctuate less), and your own risk tolerance.
It's never too late to consider the opportunity to rebalance your portfolio if it is appropriate. Would you be more comfortable with a heavier weighting in bonds and cash? If you find it hard to answer that question, consulting with a wealth advisor in Houston, TX, may be in order.
Generally speaking, your assets should be reviewed at least once a year. This helps maintain the asset allocation you’ve discussed with your wealth advisors. It also addresses any recent changes to your goals, risk tolerance, or other factors.
Once you’ve rationally discussed your goals and investments with a financial advisor, it is important that you stay invested for the long term, even if markets are volatile in the short term. In other words, stay calm, stay diversified, and stay in the game.
Selling stocks only because of a short-term decline in equities may not be the best strategy. In fact, it can harm your investments in several ways: First, historically, the U.S. stock market has tended to rebound after a bear market and continue to go upward. That means that if you sell into a bear market, you may not be cutting your losses (a popular misunderstanding). Instead, you could be ensuring that you miss out on at least part of the potential rebound and subsequent climb.
Second, if you make a habit of reinvesting your dividends, putting your earnings to work for you, a stock market decline increases your purchasing power. As a result, you can buy more of a lower-priced stock than you could of a higher-priced one.
The same is true of purchasing more stock on a steady basis. In down markets, your money goes further, acquiring more shares. In short, investors control their emotions regarding the actions of their investments. They keep their eye on the long game.
Some folks like to manage fears and emotions by collaborating with a wealth advisor in Houston, Texas, who looks at their investments during down periods (rather than managing through it themselves). A wealth advisor can potentially provide confirmation of your goals and report, providing you with updates regarding your plan.
If a correction in financial markets is inevitable, it can be made easier to navigate by having a comprehensive wealth management plan in place. Your wealth advisor can work proactively with you to provide a comprehensive strategy for working toward your goals in all areas.
Once your portfolio is diversified appropriately—meaning not only among asset classes but within asset classes—some of your investments might do well, even if others are experiencing short-term downturns. When that happens, your progress toward your goals can continue.
Wealth advisors can consult on a wide variety of financial needs, including asset classes. At the same time, they can help ensure that your money benefits from wise tax strategies, prudent investing on a steady basis, planning for your heirs, and more.
Linscomb Wealth brings experienced insight for you to rely on. Contact us today for advice on getting through economic downturns.