Last week, the S&P 500 started strong, but began dropping mid-week. On Friday alone, the market fell about 2%. Looking at one year comparisons, we are still higher than last year. The volatility, or the ups and downs in the market, is going to continue for the foreseeable future.
We’ve had mixed financial news lately. US banks underwent stress testing and passed, meaning they are in overall good financial shape. At the same time, they still need to increase their reserves to make sure they stay in good shape.
We saw consumer spending rebound in May, but incomes continue to drop, and consumer sentiment, that is, peoples’ thoughts on the economy, dropped in June with fears of a resurgence in the virus. When you add in continued social upheaval and a universal designated hitter in baseball, we should not expect to see calm markets any time soon. That square root recovery is looking more likely.
The good news is that, for people who are in the accumulation phase, that is, people still working and saving for retirement, the volatility can be a good thing. If you are fortunate enough to still have your job, making regular contributions to your retirement accounts allows you to dollar cost average. By investing the same dollar amount at regular intervals, you automatically buy more shares when the price is low, and fewer shares when the price is high. For example, if an investment costs $50, and you normally invest $200, you will buy four shares. If the price soars to $100 a share, you will only buy two shares the next time. And if it drops to $25, you would buy eight shares. Over those three periods, you’ve bought 14 shares. The average share price was just over $58. But you paid, on average, about $43 a share, when you figure you bought 14 shares for $600.
When prices drop, you are buying more shares. If you’re still working, that’s a good thing. Price drops also allow you to make tax-efficient moves, such as Roth conversions or tax loss harvesting. These seemingly small things now can have a big impact in retirement.
But what to do if you’re rapidly approaching retirement, or already there? Reverse dollar cost averaging is a fast way to deplete your savings. That’s when you’re selling more shares to get the same amount of income during a price drop. There are several ways to help mitigate these drops.
For the right person, in the right situation, an annuity may make sense. An annuity is an insurance product. An easy way to think about it is that an annuity is the opposite of life insurance. Life insurance is something you pay into that creates an estate, or a lump sum of money, when you die. It protects your family if you die too soon. An annuity liquidates an estate. You give that lump sum to the insurance company, and they send you a regular distribution. It protects you against living too long, or outliving your money. I’ll be honest and say that I think annuities are oversold, due to the large commissions they pay. If someone is recommending one to you, be sure to ask why that product in particular is best, why that insurance company, and how much the agent is getting paid.
Another option for mitigating market volatility is using a bucket strategy. You divide your investments into groups; some money, usually in cash or very conservative investments, is for the short-term, so if there is a drop in the market, you can draw from your short-term bucket. You can have another bucket that produces income, usually by dividend-paying stocks and bonds that generate interest income. Finally, you can have an aggressive bucket, where, in a year like 2019, you can sell those growing assets to produce income. In a down market, you wait for them to recover, using your first bucket that was earmarked for short-term spending.
There are several more variations on the bucket approach. If you’re worried about market downturns affecting your retirement, talk with your advisor.
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Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a Registered Investment Advisor. CovingtonAlsina and Great Valley Advisor Group are separate entities from LPL Financial.
All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The opinions voiced in this show are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investment(s) may be appropriate for you, consult with your attorney, accountant, and financial advisor or tax advisor prior to investing.
And if you don’t have a financial advisor, come talk to us. This is Ann Alsina with CovingtonAlsina.