Preparing for, and Dealing with, Market Turbulence

At Peterson Wealth Advisors, we manage the retirements of several retired commercial pilots. As I have discussed these pilots’ careers with them, one of the retired pilots explained that being a pilot can be described as, “hours and hours of boredom punctuated by moments of sheer terror.” Although these moments of sheer terror are rare, pilots will spend countless hours of training throughout their careers preparing for that moment when their flight plan might not go according to plan.

Just as pilots have a plan, investors also need to have a plan to follow when their investments are not going according to plan. The last couple of years have provided investors ample unplanned and unforeseen investment turbulence. A pandemic, a supply chain crisis, the highest inflation rate in our lifetimes, and the prospects of another world war in Europe have certainly rocked the investment world and caused even the best-made investment plans to not go according to plan.

Investors should always be asking, “what is my plan when things temporarily aren’t going according to plan?” Let me share with you the Peterson Wealth Advisors’ perspective and what we are doing for our clients when it appears that things aren’t going according to plan due to ‘investment turbulence’.

Embrace the Volatility

First, temporary downturns are not a deviation from the plan. Rather, they are an expected part of the plan. Stock and bond market downturns are always temporary, and historically the duration of almost every major decline is measured in months, not years. The media would have you think that market corrections, “are unexpected events that are shocking in both their occurrence as well as their impact.” As investors with longer-term perspectives, we understand that the price you pay for inflation beating investment returns consist of enduring occasional periods of market volatility. Few of us would pass up a Hawaiian vacation because there will surely be some turbulence in our flight to and from Hawaii. We likewise need to keep temporary market downturns in perspective and remember that turbulence is a planned for event.

Even though the exact timing of a correction is difficult, we should expect and even embrace market volatility. Investors should seize the opportunity to make wise tax moves during declining markets by doing Roth conversions, rebalancing portfolios, tax-loss harvesting, and then be opportunistic by purchasing depreciated equities while they are being sold on discount.

Protect Gains

We believe that investors should never be in a position where they need to liquidate depleted investments due to a temporary market downturn. This is difficult to do if an investor is not preparing for the downturns before they happen. With the Perennial Income Model™, we proactively attempt to protect our clients from selling investments at a loss by following a rigid, goal-centric, approach to harvesting investment gains once the goal of an investment has been reached. Harvesting is the process of transferring aggressive investments to more conservative investments as goals are achieved.

Navigating retirement with a plan that establishes investment goals and appropriately harvests gains can bring order, discipline, peace of mind, and added security to the retiree.

Maintain Flexibility

If you have the flexibility, you can wait out market downturns and wait for good investment opportunities. The best way to add flexibility, and tip the investment odds in your favor, is by simply increasing your time horizon. The longer you are invested, the better opportunity you have to endure a range of market outcomes. This endurance flexibility lets you stick around long enough to let the odds of benefiting from a positive outcome fall in your favor.

Additionally, flexibility within an investment portfolio allows Peterson Wealth Advisors to select only positive performing investments within a portfolio to be drawn upon for income. This allows investments within that same portfolio, that may have temporarily dropped in value, to rebound.

Flexibility gives you room for error and giving yourself a margin of error is the only way to safely navigate the world of investing, which is governed by probabilities, not certainties.

Create a Plan that has Conservative Projections

In other words,  plan for the worst and hope for the best. As the creators of the Perennial Income Model™ we project retirement income streams over decades. This process is unique to our firm. We have concluded that it is in everybody’s best interest to project low. We assume future investment returns 30% less than historical averages in all of our planning and projections. If an acceptable retirement income stream can be created from the conservative assumptions that we use, an actual income stream that spins off more income than originally projected will certainly be welcomed.

Conclusion

Market turbulence has and will continue to afflict investors with regularity. This is why we choose to create retirement income streams by following the goal-based, time-segmented processes of the Perennial Income Model.

A retirement income plan is only successful if it can survive reality, and a future filled with unknowns is everybody’s reality. That is why we feel it is important that retirees understand and embrace volatility, follow a goal-based plan to protect investment gains, maintain investment flexibility, and use conservative estimates as retirement income streams are projected. If retirees understand and embrace these points, they will be prepared to answer the question, “what is my plan when things temporarily aren’t going according to plan?”

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Strategic Opportunities in a Market Decline

“A pessimist sees the difficulty in every opportunity; an optimist sees the opportunity in every difficulty.” – Winston Churchill

As I watch the emotional reaction of investors during market turbulence, I concur with Churchill as I see individual investors categorize themselves into two separate camps. They are either victims or they are opportunists.

Beyond reminding the self-prescribed investment victim of the overwhelming historical evidence of the resiliency of the stock market, there is little that can be done to save them from themselves as they panic and sell as markets decline. Therefore, let’s not waste our time discussing how to rescue the lemmings as they throw themselves off a cliff

Let us focus instead on the positive steps that can be taken by an investment opportunist when stock markets retreat. There is so much that can and should be done in every financial crisis. The prepared opportunist can turn today’s temporary stock market lemon into tomorrow’s lemonade.

An investment opportunist recognizes that every downturn is temporary, every bear market is eventually followed by a bull market, and that the stock market will eventually go on to reach new record highs. There has never been an exception to this pattern, only the timing and duration of the bear and bull markets is uncertain.

Six ways to take advantage of a temporary market downturn:

1. Roth IRA Conversion

A traditional IRA will someday be taxed while a Roth IRA grows tax-free. Therefore, Roth IRAs are more advantageous to own than traditional IRAs. You can convert a traditional IRA to a Roth IRA, but you must pay income tax on the entire amount of the traditional IRA that you convert. So, let’s say you own 10,000 shares of ABC stock that are priced at $10 per share. The value of your investment is therefore $100,000. If you were to convert these 10,000 shares at the $10 price you would need to pay income tax on the $100,000 converted to a Roth IRA.

In a down market, an opportunist would realize that his ABC stock is now only worth $7 per share. If he were to convert all 10,000 of his shares that are now worth only $70,000, he would only have to pay tax on the $70,000 Roth conversion, not the full $100,000. When the price of ABC stock rebounds to $10 per share our optimists would have $100,000 worth of Roth IRA value but they would have paid tax on $70,000 worth of Roth IRA conversions.

2. Refinance Your Mortgage

When the stock market recedes, it is common for the Federal Government to step in and attempt to jump-start the economy. They do this is by reducing interest rates. This move will often temporarily reduce mortgage interest rates. The opportunist would jump at the chance to refinance their mortgage because a thirty-year, $300,000 mortgage with a 3.5% interest rate costs $60,000 less over thirty years than the same mortgage with a 4.5% interest rate.

3. Fund IRA/Increase 401(k) Contributions

An easy way to take advantage of a temporary market downturn is to contribute additional funds to retirement accounts. We have all heard the maxim, “buy low, sell high”. Well, then buy when equities are selling at a discount.

Some of you will remember the years 2000-2009 which was the worst decade for investing since the great depression. Large stocks ended the decade at the same levels that they began the decade. That’s right, ten years with zero growth. The pessimist would say, “I am glad, or I wished, that I missed out on that disaster”. Meanwhile, for the opportunist, this decade was a wonderful investment opportunity! As markets went down the opportunist systematically purchased depleted equities in their 401(k)s and IRAs at a substantial discount. These once depleted shares are now worth 400% of their 2009 value and that’s taking into consideration the latest downturn.

Those who make annual contributions to retirement accounts should contribute when markets plummet. Those who systematically contribute to 401(k)s should consider reallocating conservative investments within their 401(k)s to equities and/or increasing their 401(k) contribution rates.

4. Rebalance Your Portfolio

There is proven value and additional security when investors diversify their investments. Few would argue that diversifying or creating the proper mix of investments to accomplish specific goals is important. The challenge is keeping portfolios diversified. As markets fluctuate, portfolios get out of alignment as top-performing investments become a bigger allocation and underperforming investments shrink to a lesser allocation of the original portfolio mix. Rebalancing brings the investments back to the original mix. The process of rebalancing requires buying and selling securities which ofttimes create unwanted taxable gains. Rebalancing can be accomplished during market downturns with greater tax efficiency because the capital gains incurred are less as depleted equities are sold.

If it so happens that your rebalancing requires purchasing equities to bring your portfolio back to its original composition, then rebalancing adds additional value as temporarily beaten up equities are purchased at discounts.

5. Tax Loss Harvesting

Let’s say that Clara bought a mutual fund three months ago for $100,000. Because of the recent slide in equities, this investment is now only worth $80,000. Clara could simply hold on to that investment and wait for it to rebound to $100,000. There would not be any tax benefits or consequences by waiting for the depleted shares to rebound.

However, Clara is an opportunist and hates paying income taxes. She decides to sell the diminished investment and create a $20,000 capital loss which would benefit her taxwise. She then invests the $80,000 into a very similar investment to that which she sold and when the market rebounds she would still have the $100,000 of value plus a $20,000 capital loss that could save her several thousand dollars in income taxes.

6. Invest Excess Cash

The most important criteria to consider when deciding how to invest is time horizon, or how long money can be invested until it is needed. Money that will be required in the next five years for a purchase or for income should not be invested in equities because of the short-term volatility that accompanies the stock market. Money needed between five to ten years should be moderately invested into a mix of equities and fixed-income investments. Money that will not be needed for ten years and beyond should be invested in equities to help fight inflation. Market corrections provide opportunities to reassess portfolios and put money that is on the sidelines to work.

A Concluding Thought:

The richest men in the world, from every generation, did not get that way by betting against the ingenuity and indomitable spirit of the human race to create a better life for itself. Successful investors have always been richly rewarded for their willingness to invest in the future. This generation is no exception. Today’s optimists, or those willing to invest a better tomorrow, are thriving.

Don’t Make Retirement Investing Decisions Based on a Headline

The other day I saw a headline that read “Cancer overtaking heart disease as leading cause of death in many states”.  The headline grabbed my attention and I continued to read to see if my state was one of the states where cancer was on the rise. Upon further investigation, I found that cancer deaths per capita are lower now than at any time in recorded history. What is really happening is that with fewer smokers and healthier lifestyles, heart disease is killing fewer people thus making cancer, with the lowest death rate in history, the number one cause of death in certain states.

I don’t think there was any attempt to deceive the reader in the headline about cancer and heart disease, but I see on an almost daily basis attention grabbing headlines from the financial media that will say anything to capture the reader’s or listener’s attention no matter how deceptive their headlines might be.

CNBC ended 2018 with the following headline: “US stocks post worst year in a decade as the S&P 500 falls more than 6%”. Then my radio told me we just had the “worst December for stocks since 1930”.

These factually true, yet misleading headlines are quite shocking if historical perspective is not provided and historical perspective is never provided. Historical perspective destroys the “shock and awe effect” and frankly, shock and awe sells. Historical perspective also destroys the credibility of any person or entity that sells shocking headlines about equities to the public. So, you aren’t going to see much historical perspective from the financial media any time soon.

Let’s put some historical perspective with those truthful yet misleading headlines. Money invested into the S&P 500 at the beginning of 2018 would have lost 6% for the year but a prudent investor would not invest short term money (one year) into a long-term investment such as equities.

What would be the current value of $10,000 if it were invested into the S&P five years ago or in December of 2013? Today’s value would be worth $14,894 or an annualized return of 7.4%.

How about $10,000 invested ten years ago or in December of 2008? That $10,000 would have grown to $32,771 today representing an annualized return of 12.6% for the decade.

How about investing over a long period, say since the end of WWII? $10,000 invested into the S&P 500 since May of 1945 would be worth more than $18 million averaging an annualized return of 10.76% per year.

What is the moral of this story? Ignore the shocking short-term headlines when it comes to your long-term investments.

Scott M. Peterson is the founder and principal investment advisor of Peterson Wealth Advisors. Scott has specialized in financial management for retirees for over 30 years. Scott is a regular presenter at BYU’s Education Week and speaks often at other seminars regarding financial decision making at retirement. He also literally wrote the book on retirement income, Plan on Living: The Retiree’s Guide to Lasting Income & Enduring Wealth.

If you are getting close to retirement and will have at least $500,000 saved at retirement, click here to request a complimentary copy of Scott’s new book!

The World’s Worst Investments – Gold and other precious metals, and Index Annuities

In past blogs, we have offered you some insight into the very temporary nature of a bear market as well as the illusion that equities are a dangerous place to invest. With these two blogs as a foundation, we would like to warn about certain types of investments that could do serious damage to your retirement. These investments not only have horrendous track records, but they are almost exclusively purchased as a result of an emotional reaction to a short-term downturn of the stock market or as an emotional reaction to the mere possibility that the stock market will decline. As we have seen again and again, when emotions and investing combine, there is seldom a good outcome.

In our estimation the worst types of investments you can buy are precious metals and index annuities. You may be very familiar with these products because these industries are the predominate advertisers on the cable news networks. One can surmise, from the sheer volume of these industry’s advertisements, that they must be very successful. First, they are successful in convincing the unwary public of the virtues of fleeing the stock market and also in duping the public into buying their perennially underperforming products.

The argument against buying Gold and Precious Metals

The thinking is that if, for whatever reason, countries and their currencies cease to exist, then precious metals will be one of the few items that will hold value and preserve purchasing power. The question is, “To purchase what?”

If all the currencies of the world had no value, the world would be in utter chaos. Anarchy and revolution would rule. This has never happened on a large scale in the history of our world, so nobody has a credible idea of what a world without currency would look like. There would be no manufacturing, no food production, and no police or armies to protect us. There would be no commerce—that’s right, stores would be shuttered. Why would anybody choose to work if there was not a way to be paid for labor rendered?

So, even if your ounce of gold held its value, what could you buy with it? Where? How? In our estimation, a homemade meal would be worth more than an ounce of gold, if you were fortunate enough to locate the food and a willing cook to put it together for you.

Doomsday predictions and conspiracy theories have never been a friend of the disciplined investor and at Peterson Wealth Advisors, we simply refuse to fan that flame. If, however, you are one of those who thinks that chaos and revolution are the destiny of our society, you might as well step away from the computer and get back to building your bunker. But before you go, we would like to share with you one important thought. The richest men in the world, from every generation, did not get that way by betting against the ingenuity and indomitable spirit of the human race to create a better life for itself. Successful investors have always been richly rewarded for their willingness to invest in the future. This generation is no exception. Today’s optimists, or those willing to invest in a better tomorrow, are thriving.

For those of you who are not planning on living in a bunker, but are considering owning some gold, perhaps as an inflation hedge, let us share with you some facts.

First, although touted as an inflation beater, gold does not keep up with inflation. In 1980, the price of gold was $850 an ounce. The price started a decline over the next twenty years and bottomed out at less than $300 per ounce at the start of the new millennia. It then shot up during the first decade of the century, peaking at over $1,800 per ounce in 2018, and now has settled back to about $1,300 per ounce.

With all its volatility, gold has gone from $850 an ounce to $1,300 an ounce over thirty-seven years. That works out to be a rate of return of less than 1% per year. Meanwhile, the cost of goods and services, or inflation, grew by 3.1% annually. The price of gold does not keep up with inflation and no matter how many times the lie that “gold is an inflation fighter” is repeated on your cable news network doesn’t make the lie anymore true.

Precious metals are advertised as safe havens from the turmoil of the stock market, yet they are neither safe nor dependable. The price of gold, and other precious metals is extremely volatile. In fact, the price of precious metals has historically been more volatile than the stock market. It is hard to understand why anyone would want to own any investment that fluctuates wildly in price, never pays a dividend, has a dismal track record and can’t keep up with the inflation.

So, when well-known actors advertise that they buy gold because they are “good Americans concerned about the future,” please try to see through the deception. They tell you to buy gold because they are actors who get paid to tell you to buy gold.

Index Annuities are insurance products

They advertise that you can participate in some of the returns of the stock market in the good years but that you will not lose money in the years when the stock market retreats.

The sales pitch of these products is enticing, but the devil is in the details.  First, these products have caps or limits on how much they will pay when the stock market goes up. So, when the stock market goes up, earnings within these products are limited to the prevailing cap of the product. If the stock market goes up 10, 15, or even 30% in a given year, these products will pay to you only the prevailing market cap. In most instances, these caps can be changed by the insurance companies without warning. The consumer has no say. The prevailing market cap currently is 5%.

Second, these products have severe penalties if you liquidate your investment before the surrender period expires. Surrender periods are imposed because the insurance companies that create these products pay a large upfront commission to the insurance agent who sell these products. If an index annuity owner cancels their annuity before the surrender period expires, the insurance company can recoup the commission paid to the agent from the surrender charge assessed to the annuity owner. The surrender periods typically last seven to ten years. Surrender charges can run as high as 10% of the value of the annuity.

Third, index annuities don’t participate in the dividends of the underlying indexes they follow. This is significant. Almost half of the returns of the S&P 500 can be attributed to the dividends of the companies that make up the S&P 500 index. So, if you choose to invest into the stock market via an equity index annuity, you automatically cut your profits in half by foregoing future dividend payments.

To better illustrate the absurdity of these products, let’s apply the same investment criteria used in an index annuity to a real-estate transaction.

The deal would go something like this: “We will take your money and invest it into a rental property. Your investment is guaranteed to never lose money, as long as you leave the money with us for at least ten years. If you liquidate prior to ten years, you will be subject to a surrender charge as high as 10% of your initial investment. Additionally, you will not receive any rental income stemming from your investment, but we will pay you a portion of the annual increase of the value of your property each year, and the amount we will pay you will be completely up to our discretion. Oh, and by the way, thank you for paying us an upfront commission of 7% of your purchase. It’s been a pleasure doing business with you.”

Of course, nobody would agree to a real-estate deal like this! Why would we agree to similar terms with our other investments? There are hundreds of index annuities to choose from, and they all have variations on how they credit earnings and apply surrender charges. Even though all index annuities are different, they share a common trait. Index annuities are complicated products. Few owners of index annuities really understand how their annuities really work. People buy these products because they know that there is some type of guarantee associated with them. However, it is our belief that if the consumer really understood index annuities, they would never purchase one.

Before investing any money into an equity index annuity, do your homework and understand how these products are structured. The Securities and Exchange Commission has issued alerts to the public regarding the potential pitfalls of index annuities. The only advocates of index annuities that we come across are those companies that create them and the insurance agents who sell them.

What About the Guarantees?

The draw to these products is their guarantees. The only positive guarantee is that index annuities offer is that you won’t lose money when the stock market goes down. Since every market downturn is temporary, that isn’t much of a guarantee when you consider all that you lose by owning these products.

Owning an index annuity will certainly provide additional guarantees—undesirable guarantees.

Owning an Index Annuity Guarantees:

  • That you will never get stock market–like returns. Market caps ensure this will never happen.
  • That you will never be paid a dividend. Dividends historically account for almost half of the growth of the stock market.
  • That you will never be able to beat inflation over the long run by investing into their annuity, again thanks to market caps and no dividend payments.
  • That you just paid one of the highest commissions in the investment universe to the insurance salesman who sold you the annuity.
  • That the bulk of your money will be locked up inside one of these products for as long as a decade. Certainly, lump-sum distributions are available to you if you are willing to forfeit as much as 10% of your principal to access your money earlier than what is allowed by the annuity contract.

So, why are index annuities so prevalent? Unfortunately, they pay some of the highest commission of any product in the investment industry. Need we say more? Index annuities are sold by insurance agents, and for many agents, index annuities are the only product in their quiver that could loosely be called an “investment.”

Frightened, unwary investors purchase precious metals and index annuities because they fail to distinguish the difference between volatility and risk. Those who purchase these products have been duped by the emissaries of gloom that promote an irrational fear of equities, and fear is a powerful tool. A tool so powerful that the impressive weight of historical evidence manifesting the inflation-fighting power of equities is ignored and traded for the false promise that your money can “safely and dependably grow and beat inflation” while invested in precious metals and index annuities. Thankfully, knowledge is likewise a powerful tool and as you continue to investigate, you will become increasingly aware of the foolishness of owning precious metals and index annuities.

Scott M. Peterson is the founder and principal investment advisor of Peterson Wealth Advisors. Scott has specialized in financial management for retirees for over 30 years. Scott is a regular presenter at BYU’s Education Week and speaks often at other seminars regarding financial decision making at retirement. He also literally wrote the book on retirement income, Plan on Living: The Retiree’s Guide to Lasting Income & Enduring Wealth.

If you are getting close to retirement and will have at least $500,000 saved at retirement, click here to request a complimentary copy of Scott’s new book!