What did we learn from 2020?
2020 was a year of records, stark contrasts and wild swings in the stock market. We started the year with record (or near record) employment and ended the year with record unemployment. The stock market witnessed new records for both the shortest bear market in history and the fastest bear market recovery in history.
March 2020 set new records for intraday volatility. The acceleration and depth of the suffering caused by COVID would have been virtually impossible to forecast on Jan. 1, 2020, and attempting to do so would have been essentially guesswork. And despite all this, the stock market as measured by the S&P 500 gained about 16% for the year, a well above average return.
There are lessons to be learned from the events of 2020. An important one is to be prepared for uncertainty by incorporating “uncertainty” into a financial plan. As planners, we can prepare for uncertainty in a number of ways, for example, by using conservative planning assumptions for variables like expenses, investment returns and market volatility.
We can also “stress test” financial plans for unlikely or extreme scenarios that provide the client with better insight and guidance on how to deal with and prepare for an untoward event. True, planning for uncertainty involves subjective judgment, but a sound financial plan can provide the clarity to develop a better action plan and options.
The second lesson is “don’t put all your eggs in one basket.” We’ve all heard this, but in financial planning it can be a critically important way to help clients weather a difficult period like 2020. As planners, we advocate diversification across multiple assets classes when investing client assets. These asset classes include stocks, bonds, commodities, and real estate. Asset classes have differing correlations of returns against one another.
These varying correlations help to reduce portfolio volatility over time. Lower portfolio volatility can provide higher risk-adjusted returns and can significantly increase the probability of the client achieving the goals of their financial plan.
Third, a year like 2020 reminds us how difficult, if not impossible it is to forecast the stock market. At the beginning of 2020, many of Wall Street pundits had bullish outlooks. At the depths of the market decline in March, many of these same pundits were advocating caution with respect to the market.
This is not to say they aren’t smart. They may be quite smart. But short-term market forecasting is nearly impossible and the swings of the market in 2020 prove that. The lesson here is don’t try to time the market. Market timing is the biggest performance killer for most investors.
As planners, we advocate establishing an asset allocation that is based on a sound financial plan and sticking with that allocation through the ups and downs of the market. This will help to keep clients on track with their long term goals and reduce the probability of destroying long-term returns by trying to time the market based on emotionally driven decisions.
Robert Toomey, CFA/CFP, is Vice President of Research for S. R. Schill & Associates on Mercer Island.