As significant events go, a global pandemic certainly makes the cut. It’s affected us all emotionally and will have had most people thinking about their finances and what the future might hold. How might we be affected in the next few weeks, months and years?
This might be in regard to our investments and retirement funds falling in volatile markets, the impacts to our jobs and financial security during a recession, or even as simple as putting food on the table – in the early days of lockdown, I think many of us experienced that sinking feeling of going into a supermarket to not be able to find one of life's most basic necessities.
“Painful as it may be, a significant emotional event can be the catalyst for choosing a direction that serves us - and those around us – more effectively. Look for the learning.” ―Louisa May Alcott
It’s with this, that investors who didn’t already have a financial plan should take stock. Let me ask you this - what if you had known that this event was coming? Maybe not within a few weeks’ notice (as you’d likely have sold down everything to cash), but maybe that it would come within the next 3-10 years. What would you have done differently?
I’d make a guess, that there are a few things you might have changed were you to have had this crystal ball. In which case, now is the time to step back, learn from this experience and put yourself in a better position to get through the next significant market event. Because there will be another one. It might be 3 years away, it might be 10 years or more – but it will come.
And it’s also worth adding that from an investment standpoint we shouldn’t worry too much about the next stock market downturn. As flippant as that might sound, ultimately, it’s not something you or I have any control over, so it’s not worth wasting mental energy on. Likewise, the long term returns of investing in the stock market come from the risk of investments falling in the short term. Not to be encouraged, but certainly to be expected.
Over the coming months, there is likely to be more volatility, along with significant impacts on individuals from a global recession. But through this, keep in mind that every stock market downturn so far has led to:
- New market highs
- New record low levels of unemployment
So, with the above in mind, what can we learn from the last few months? If you didn’t have a plan before, what forms the basis of a sensible financial plan and what should you be thinking about in order to be on a stronger footing for the future?
1. Topping up or building your emergency cash reserve
The fundamental starting point and cornerstone of any financial plan is keeping a suitable amount of readily accessible cash to hand. Boilers break, roofs leak – having cash to cover the unknown is important.
But there’s another incredibly important reason to hold some cash. If you have been invested in the stock market for the last few months, the likelihood is that you’ll have seen your pension and investments fall quite substantially in a very short period of time. Investments falling in value is never an enjoyable experience, but it becomes far less comfortable when you are reliant on that money for any short-term liquidity.
Let me ask you another way – would you have been more comfortable riding out the market volatility if you had kept more cash to hand? If yes, then now is the time to build up the cash reserve to a sensible level.
- Give you that emergency buffer for when things go wrong
- Avoid you making short term decisions on long term investments i.e. those who panicked and sold their investments – then missed the near 40% recovery
- Potentially enable you to invest a higher proportion of your assets in long-term investments, with aim of achieving higher returns as you can more comfortably ride out market volatility
- Ensure your finances are robust enough for a market downturn or recession – your income/bonuses could be reduced, or you might face redundancy. Having cash put aside to cope with this will take significant stress out of the experience.
So how much cash should I hold?
Typically, this is something like 6-9 months’ expenditure as a starting position. Then take into account your personal risk tolerance and how you have felt over the last 3 months. This is not a hypothetical question any more – whilst these feelings are fresh and real, we can use them to guide our decisions. Likewise, your relative job security, various investment pots and wealth should all factor into this equation.
2. Investment risk that is right for you
I think it’s fair to say, when markets are moving upwards it can make everyone feel a bit like Warren Buffet. If everything is increasing in value, it is hard not to make money in the stock market and we’ve certainly met people who think investing is easy or that they have a very high tolerance to risk.
As a general rule, the more risk you are willing to take with your investments over the short term, the higher return you’d expect to receive over the long term. Receiving higher returns for additional risk is a core concept to investing and makes intrinsic sense, as otherwise why would you take additional risk?
The thing is, saying you’re comfortable with a short-term fall to your portfolio is a very different story to actually being comfortable when it happens.
So let’s look at how you’ve felt over the last few months. Did you check your portfolio every day, did you feel anxious and call up your adviser wanting to sell? If you didn’t have an adviser to guide you through this – did you end up selling? Or conversely, did you see this as an investment opportunity and look to invest more through the falling markets?
If so, it’s time to take stock and think about the reality of your risk profile and the right level of risk for your various investment pots.
Let’s look at a simple example. The below shows the growth of the MSCI All Countries World index, which is a good representation of the global stock markets.
If you had invested £100,000 in January 2001, you’d now be sitting on more than £300,000. Sounds easy right?
But look more closely, would you have held your nerve?
Imagine yourself as an investor in January 2001 - you’ve just made a big investment and then it falls -15% in the first year. Trusting things would recover you didn’t sell, but then watched as your pot was down nearly -40% by October 2002. Your £100,000 now worth around £60,000. Ouch.
Ask yourself this: would you have thrown in the towel? If you had, you’d have missed out on more than 92% returns over the following 5 years. A classic case of buying high, selling low.
The point here is taking more risk than you are comfortable with is a sure-fire way to either give yourself a heart attack, lose money, or potentially both. It’s far better to diversify and reduce investment risk, than be a forced seller because things get too much. As an example, rather than being down more than -40%, the average diversified fund, with equity exposure of between 20-60%, fell by -17.5% over the same period. Certainly an easier pill to swallow, but could also equate to higher returns if it avoids you selling at the wrong point.
Since January this year the markets are broadly flat. The markets have recovered rapidly since the lows of March, so take advantage of a second chance to get this right. Next time round, the recovery might take longer to come, but when it does it often comes quickly - selling out and losing your nerve means missing out on the recovery.
3. Review your investment strategy
We’ve just seen a very large correction in the stock market, followed by an enormous recovery. Both how quickly the market fell and recovered is something unseen in previous years. But how did your pensions and investments actually fair? “Could do better”?
I mentioned in the last section, rising markets make everyone feel like Warren Buffet. Well he put it very succinctly talking about falling markets when he said the following:
“You only find out who’s swimming naked, when the tide goes out.” ―Warren Buffett
So how did your adviser or investment manager perform when the tide went out? When was the last time you objectively reviewed their service or benchmarked their performance? Are you even able to, if like many you have pension pots dotted around with various companies?
The markets have broadly reset since January, where they go from here is down to factors outside of your control, but you do have control over the investments you hold. Review their performance or find an adviser who can – it’s about setting yourself up for future success. You can’t afford not to.
4. Prepare for the unexpected
I’ve written previously, on what a profound effect seeing our prime minister giving an impassioned speech about the NHS saving his life when things were “50/50” had on my father. But events like this will make all of us think about the effects of something happening to one of us. How would my family cope? Would they be looked after?
“By failing to prepare, you are preparing to fail.” ― Benjamin Franklin
Take steps to get your house in order. This is a case of fixing the roof whilst the sun is shining and far too few people haven’t tackled this topic, out of the awkwardness of the conversations, or simply putting things out of sight and out of mind.
Make a Will
If you haven’t got a Will, you’re leaving what happens to your finances to the laws of probate – not only is this likely to not be what you intend, but it can be incredibly tax inefficient for your loved ones. You should also have a grown-up conversation with your family members about this, as there will be things you haven’t considered.
Update your existing will and letter of wishes
It seems for those who have a Wills, very few have them up to date. Not only does this legally direct your assets to those you care about, but these documents are used to guide your loved ones to your intentions – not just on your assets but on other very difficult and thorny issues. Update these documents. Not doing so is putting unfair stress and decisions on those who will be mourning.
Nominate your beneficiaries on your pensions
Pensions don’t follow the rules of probate or your Wills. I’ve previously written a blog post about this here, with some free forms to complete this yourself. Please review these or have an adviser do so, it’s all too common we see the wrong person listed here and pensions don’t suffer from inheritance tax so vital you plan your beneficiaries correctly (as part of the planning for your Wills above).
Setup powers of attorney
If something happens and you lose the mental capacity to make decisions, it’s sensible to have already nominated who can make choices for you – both about your finances and your health. Imagine if your money is all tied up in your name and your partner can’t access it to pay the bills.
A power of attorney document does just that. You can set these up yourself, but if you’re sorting out the Wills a good solicitor will also be able to organise these at the same time for you. If you’d like some names of solicitors we’d recommend, do please drop me an email.
Protection policies & personal insurance
You should speak to an adviser and review the level of protection you have in place. If you think about the income and time you provide your family from now until retirement, if you can’t work due to ill health or aren’t around, will your family have enough to get by? And don’t just have enough protection to pay off the bills, you need to have enough to continue saving for retirement too.
Some things to consider:
- Life cover and/or critical illness cover to pay off any large debts, like the mortgage.
- Life cover to cover the loss in family income if something was to happen to you or your partner
- Income protection, to provide income for the family if you can’t work due to ill health
And once set up, some of these policies should be put in trust to ensure your beneficiaries get access to the money swiftly, but also reduce the likelihood of a potential 40% inheritance tax charge. This can be tricky, so you may want to consult an adviser.
Make a list of your assets (and your online accounts!)
Make life easy for your loved ones. If the worst was to happen, they don’t know all of the bank accounts, pensions or investments you have. I very much doubt you’ve got an updated list with your Will either. So think through how they would work all of this out.
When people are mourning, the last thing they need to be doing is playing inspector Clouseau trying to track everything down, especially if they need this information to pay the bills or funeral expenses. The good news is if you have an adviser, they will know your assets and do the heavy lifting here.
Also, think about your online accounts – all of your photos stored in the cloud, all of your friends contact details in your email account. These will be important to obtain and have very high sentimental value to those you leave behind.
5. Change the habit of a lifetime
Habits and routine are incredibly hard to change. It requires enormous amounts of effort to pick up a new habit and build it into our daily routine. But overnight, we’ve all had our routines turned on their heads - and in this there is opportunity.
“Excellence is an art won by training and habituation” ―Aristotle
Some may have been able to use this change to kickstart their fitness routine, or to start learning a language (I’m diligently doing Spanish every day now), but let’s think about this in terms of the finances:
- Your gym memberships have stopped
- You’ve not spent money in pubs and bars
- Discretionary spending in general is down
At some point (hopefully soon), things will start returning to normal. Ask yourself this: will your expenditure jump right back up to the level it was before?
There’s a good chance that you could lock in to a new budget. Save more, spend less. A new habit to last a lifetime. It might not be dramatic, but perhaps you don’t need that gym membership?
Forcing yourself to a new budget, where you save and invest a little more than now each month could make a dramatic difference to your future wealth. That could mean saving up for the holiday of your dreams, or retiring years earlier - think about your expenditure right now as it will help you work out what’s core and what’s not in the future.
6. For heaven’s sake, cashflow model and build a plan
Finally, I would urge everyone to have a cashflow model of their finances. It doesn’t matter if this is something you’ve built in excel, or something more sophisticated like our Lifeline we use for our clients – everyone should be doing this.
A cashflow model helps answer all of the things raised above:
- How much cash should we be keeping as an emergency fund?
- How much should we be saving for the future?
- How much investment risk do we need/can we afford to take?
- How would my finances cope through a market downturn?
- How much life cover do I need to look after my family?
- Can I afford to gift assets to my loved ones now?
A cashflow model gives you comfort you’re on track to hit your goals.
“A goal without a plan is just a wish.” ― Antoine de Saint-Exupéry
So what is it? A cashflow model starts with goals – understanding your key drivers and what’s important to you. What gets you out of bed each day? What do you want to achieve in life and with your finances? Once you have that, you can then plot a model of your finances to see if you are on-track to achieve those goals. You can then start running scenarios to start really understanding the levers you have to make the finances work for you.
For our clients, having a plan has meant saying the course through market turbulence, as they know their finances have the rigger to cope with life’s inevitable (yet unexpected) ups and downs. It also takes the stress and worry out of the finances; the head is no longer buried in the sand and you know there’s a team of people who spend their time worrying about you.
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I hope the above has given you some food for thought. Taking time to step back and think about our finances, generally has positive effects to our financial futures.
As an investor, the key take home you should take from all of this is that the markets will nose dive again at some point in the future. Nobody can tell you when this might be, it could be 3 years from now or 30, but it will happen.
Having just experienced significant volatility to our investments but now broadly recovered, investors should take stock to review all aspects of their finances, to ensure they are sitting on the foundations for future success.
These are just some key points, whilst clearly there are plenty of other things to consider.
If you’d like to have a chat with one of our advisers about any of the topics raised in this article, please click here to book a call.
Whether you’re too busy to do it yourself, or just need a hand, our advisers can give face to face advice remotely and get you set up with a financial plan that will ensure you meet your goals.
This post is intended for UK retail investors. Past performance is not a guide to future performance. The value of investments can fall, and you may get back less than you invested. Please be aware that the information provided is as a general guide and for illustrative purposes and only - it does not constitute investment, tax or legal advice. You should not rely on this information without seeking professional advice from a qualified tax adviser. This is based on our understanding of current legislation which is subject to change.