Recessions, Corrections & your Wealth

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Hardly six months have passed since we were at an imminent shutdown of the federal government. Here we are again, with a near-constant barrage of 24/7 news about how the next shutdown will play out and who will be affected by it. I do not want to sound heartless and say that it will not affect people's livelihoods; it is much ado about nothing over the long term for investors, though. This relentless refusal to play ball and blame game will affect some government employees more than others. There will be ancillary repercussions for others in the form of job losses or market losses in their retirement or other accounts. However, this near-repetitive circus should also be considered a short-term noise to score some points and pander to respective bases in preparing for the constant upcoming election cycles. If you plan for decades and implement a sound strategy, short-term panics shall not force you to liquidate at an inopportune time.

That brings us to the next question? Why do these panics even happen in markets, and how can one even trust markets with such an amount of volatility happening constantly? The most straightforward answer is that someone is making money from all this volatility. That too fast money. There is a saying in capital markets that markets take a staircase when they are going up, and they take an elevator when they are going down. When people sell in panic-ridden markets, they finalize their losses and allow the short seller to capture the gain(spread) from when he/she shorted. The bigger your losses/market fall, the higher the short seller's profits. Some hedge funds specialize in this kind of activity and can remain solvent for years when the markets are going up and make a killing during volatile periods. There is a player or set of players in the market for every kind of strategy imaginable. So how does an ordinary investor, looking for that financial independence after decades of hard work, stand a chance in this shark tank-like atmosphere?

This is where past data on market cycles, some hope in the capital market system, and a sense of optimization versus maximization will be useful. The risk profile of stocks and bonds is different. Even bonds did go down in the last volatile episode due to interest rate changes. This is where another favorite quote of mine comes into play. The devil is in the details. The bond market has short-term, intermediate-term, and long-term debt instruments that are categorized into government, corporate, and municipal debt. Each of these categories and their duration will affect the portfolio differently. If you are in the accumulation phase and younger, the risk capacity vs. risk appetite is different compared to someone nearing retirement or retirement. These factors have to be considered when arranging the portfolio into near-term and far-term baskets for immediate consumption and growth possibilities.

Despite the accusations of crony capitalism and market inefficiencies, data on markets suggest that they have delivered over long terms for ordinary investors. Your 401K can be a good or bad example depending on how you or your advisor has arranged the investments in the last few years. Many accounts did well during and after the Pandemic, driven by a rally in some market sectors. It has been a combination of rallies and corrections for the past year. If you held these accounts for at least a decade and can track the deposits vs. what is in there now, you can see the effect of compounding. This is where the necessity to re-balance regularly comes in as you want to optimize the portfolio, capture the market cycle advantages, and minimize the perils of market cycle volatility. In essence, it is better to have a portfolio adjusted for 10 to 12% standard deviation than seeking returns of 20% or more while on a wild goose chase and waiting for recovery to break even. This will also depend greatly on your personality, risk-taking nature, and understanding the statistical odds of success for the amount of risk taken.

Other long-term wealth-building choices are commodities like gold, silver, or real estate. Each has its advantages and disadvantages if done, especially exclusively. For a working professional, the critical question is how much time you can spend managing your concentrated portfolio of real estate holdings or metals or commodities. The ultimate goal of anyone investing is to get that coveted financial independence sooner or later. It will be a game of snakes and ladders with the roll of dice, if adequate time is not spent on risk reward analysis. Market volatility affects metals, bitcoin, and real estate the same as it does to the stocks and bonds. Over the past few decades, there have been extreme corrections in commercial and residential real estate prices. Cash flow must be managed well in any investing endeavor to completely give up the work boots.

Another alternative often pitched to high-net-worth investors is the possibility of capturing market gains while avoiding market volatility in the form of permanent insurance or annuities. There are no free lunches anywhere. The permanent insurance policies come with their own advantages and disadvantages. It is not prudent to tie significant wealth in insurance or annuity contracts alone, as compounding potential and your decision autonomy is lost once you are locked into a contract. Prudence requires that you use it as a beneficial tool to transfer your risk to a larger financial institution to protect your spouse and children in case of an untimely death. Also, with long-term care insurance at an all-time high, permanent life insurance policies offer an alternative route to save those cash values for unforeseen illnesses with proper riders. The nuances of these contracts, especially with beneficial riders, make them significantly complex. You could buy from the same Insurance company, a policy that could have a night and day difference for your finances, because it is legal to sell them in different flavors through multiple agents.

These days, nearly everyone does not have a full pension or social security benefits that cover all expenses. Most pensions or social security benefits barely cover basic lifestyle needs. The problem is pronounced for high-income earners. To become financially independent, multiple sources of income, in addition to social security, are necessary. If you don't take enough risk, the growth will not offset inflation and will affect your lifestyle. If you take too much risk, the recovery could be longer, and if things don't go your way for a few years, you will end up in the same boat as someone who took a little risk. So optimizing the risk and seeking returns to beat inflation and maintain a decent growth rate is the goal of a well-managed plan intended for financial independence. The setup is as different as there are personalities due to the complexity and variations in risk among several investing instruments. While all this information is freely available through Google, the implementation of it efficiently is hardly available free. The costs you could incur if a few of these investing or risk steps are mismanaged are humongous. Notably, the time lost can never be recovered.

Raghu Kumar Komari, CPM?, Candidate for CFP? Certification

[email protected]

Disclosures/Disclaimers:

The commentary is provided for educational purposes only. It shall not be considered Investment Advise, Financial Planning Advise, or a recommendation of specific funds. Fees and taxes are not included in any hypothetical model or fund analysis. Please do your due diligence.