The United States is arguably in the midst of yet another financial crisis, which have occurred with startling regularity throughout all of history. We should not expect the present or the future to be any exception to this pattern of progress followed by disaster. And it is for this reason, because things will go wrong, that we create financial plans. The variables used to create such plans, such as asset allocation and tax strategies, are objective and within our full and total control. We never base any part of our plan on “unknowns” such as future market returns in a given year. Therefore, market returns in any given year have no bearing on our financial plan, assuming it has been followed. Very rarely, yet occasionally and due to no fault of our own, the plan has to change, and that is OK. The single exception to all of this, of course, is if we fail to act in alignment with our plan. Then, and only then, is it time to start worrying.
A full three years after the onset of the COVID-19 pandemic, we are still enduring its consequences. The stock market is in the middle of its longest drawdown in decades, the bond market just had its worst year ever, inflation is still at multi-decade highs, housing affordability is at all time lows, everyone is predicting a recession, and we’ve started the new year off with the two largest bank failures in US history. Needless to say, savers and retirees are frustrated and exhausted. Those of you who work with a financial planner have likely even questioned the validity of the plan that you put together. “Well,” you might think to yourself, “our plan didn’t take into consideration things getting this bad!” This type of perspective is all too common, and all of the blame for this lies at the feet of financial planners for failing to provide and constantly remind their clients why the financial planning process works. In that spirit, I aim to provide education on why the validity of financial plans persists in spite of crises, as well as give some much needed perspective to our present economic plagues (just how bad is it, exactly). In fact, that seems like a good place to start: perspective.
Since 1921, the United States has endured many financial crises. There was, of course, the infamous Great Depression, which plunged the stock market a full 89% over the course of almost 3 years beginning in 1929. Then there was World War II and the crushing debt, inflation, and stock market volatility that came with it and plagued the decade of the 40s. Inflation then came back in the 70s, and with a vengeance. At the same time, there was an energy crisis, a severe recession, and the stock market fell 50%. Oh, and all of that took about 10 years to resolve itself. Those who were adults in the 80s likely remember the “double dip” recession and the infamous Black Monday, in which the S&P 500 fell 20.4% in a single day. To put this one into perspective, imagine if your portfolio experienced the entire loss that it likely endured during all of last year in a 6-and-a-half hour period. Then came the “lost decade” of the 2000s when 2 of the 4 occasions in which the stock market fell 50% over the last century occurred. That’s right – in the past 100 years, the stock market has fallen 50% or more 4 times, and 2 of those occurred in a single decade. First, there was the tech bubble, in which the NASDAQ index fell 81% and the S&P 500 endured losses for three years in a row. And then, in just enough time for the market to recover from the last crash, the entire financial system threatened to go belly-up in what ended up being the most severe economic crash since the Great Depression. We all know the story from here: a once-in-a-hundred-year pandemic, a dementia patient in the White House, all-time-high tensions between the two largest nuclear powers in the world, inflation, rising interest rates, and now bank failures. Whew. However, despite all of the calamities, $1,000 dollars invested into the United States stock market in 1921 would be worth, with dividends reinvested, over $28,000,000 today (an average annual rate of return in excess of 10%). I’ll spell that out, because looking at the number as I’ve typed it doesn’t seem to do it justice. That’s: 28 MILLION dollars.
Human history is a perpetual cycle of progress borne out of disaster, of ups and downs, of death and resurrection. This is the cycle that has created the abundance of wealth that surrounds us! It is a cycle to be grateful for, not fearful of! Not a single person in the United States today would be looking back at their ancestors in the 1970s in a jealous fashion. And the same is true for our countrymen in the 1970s, looking back at their ancestors in the early twentieth century. We, as a country and a species, have been through far, far worse than 99% of those alive today could conjure up in their worst nightmares. And yet, we press on. In a similar fashion, plenty of people who lived through these events retired and, in spite of everything, would go on to leave a very respectable inheritance to their children and grandchildren (after a successful retirement, of course). Their financial plans endured the calamities.
So how exactly do we plan in the midst of a financial crisis? I think this question is improperly framed. We do not create financial plans in spite of crises, only to tear them up when the financial media (who, it demands reminding, has a financial incentive to make you panic), starts yelling that the sky is falling… again. This has never, and will never, be the way financial planning works. We create financial plans because of crises. If crises never occurred, or were significantly less frequent than they are today, the role of the financial planner in the lives of everyday Americans would be greatly diminished. We don’t create a plan and keep our fingers crossed that nothing will “go wrong”. Nor do we create a plan because things might “go wrong”. We create a plan because things will “go wrong”.
Furthermore, the variables which we create our plan around are only those which we have full control over. The short term performance of the stock and bond markets has never been, and will never be, a variable for which we condition our financial plans on. Why? Because they are forever outside of our control1. Variables and decisions that are within our control, however, are the ones that we set plan parameters around. What is your asset allocation before/during retirement? Do you have enough stock in your portfolio to ensure it will grow enough to keep pace with your distributions and inflation? What is your current savings rate? What is your distribution strategy for retirement? Given the current legislative environment, how can we shift around your assets in a manner that ensures that you keep as much of your hard earned wealth as possible instead of handing it over to the IRS? How much insurance do you need? How much do you have? Answers to all of these questions are objective and lie within our control to change if they are insufficient to reach our goals. This is not the case, however, for questions such as: What will the return of the S&P 500 be this year? Next year? How will the Russian invasion of Ukraine affect the market? Will the failure of banks X, Y, and Z make the market crash? What if Kanye becomes president? WHAT THEN?! Why would anyone create a plan that is conditional on the answers to any of these inherently unknowable questions?
Now, when a crisis does strike, sometimes (very rarely, and usually only if you haven’t started the planning process early enough) the plan has to change. Occasionally, at no fault of your own, life reminds you that you are not in control and forces you to deal with it. This is no different in financial planning as it is in any other arena of life, be it marriage, family, career, health, you name it. It’s important to remember, however, that you made the best decisions available to you given the data which you and your financial professional had at your disposal at the time the decisions were made. What else could you possibly have done? All there is to do under these circumstances is make whatever adjustments (which are likely small and temporary in nature) might be necessary to bring the plan back into a realistic range of success. And then, just like that, the crisis has been averted.
Crises come, and crises go. The history of the global economy is one of crisis, recovery, crisis, recovery, and on, and on. And despite the fact that it sometimes may feel that we are always getting over the last crisis and are always on the cusp of the next one, this is the process that has given us the level of wealth and living standards that we enjoy today. And it will be this same process by which future generations enjoy higher levels of wealth and living standards than us. And the current crisis, just like all of its predecessors and all future crises, will have absolutely nothing to say about it. This too, shall pass.
Notes & References
1This is entirely different from assuming a standard rate of return for different asset classes based on historical averages. That is an empirical exercise, for which we have literally hundreds of years of data. Anything besides this would be properly labeled a “guess”, and has no place in a financial plan.