The following is the third installment of our continued analysis of the recent market volatility and assessment of investors’ options given current market conditions.
As financial conditions continue to change, we’re committed to keeping you up to date on what’s going on and what you can do about it. If you’re like most people, the financial events of the past couple of weeks have you even more confused than you were when the markets were on a clear path downwards. See below for some market context, or scroll down for ideas on tips to navigate through these volatile times. If you’re retired or drawing on your RRIF, there are tips specifically for you, too.
At the time of writing, Toronto’s S&P/TSX Composite Index is up about 24% since the March 23 low. At that point, the index was down over 37% from its all-time high just four weeks earlier and at a level not seen since May, 2012. Yet, even with the index recovering a quarter of its March 23 value over the past two weeks, it has still lost almost 23% of its value over the past five and a half weeks.
In the United States, the broadest index, the S&P500 tells a slightly different story. Itself up almost 23% since its lowest point during this most recent market meltdown, the index has recovered to sit about 18% lower than its February 19 high. At its lowest point, the S&P500 had lost 34% of its historical high. Unlike Toronto, though, the U.S. index had returned to its 2016, not 2012, value.
In 2008, and into early 2009, there were short periods of rallies – at times as much as 20% – and today’s markets could very well follow that pattern. Ultimately, the market didn’t bottom out until March, 2009, which means we could be months away from the actual market bottom this time round. Most analysts still feel there is more downside risk than upside opportunity and that when markets pull back, even slightly as they did last Tuesday, it’s a reflection of investors sensing that markets are getting a little ahead of things.
We often think of volatility as market declines, but it really means a lack of predictable pattern and includes both ups and downs in the market. The image below illustrates the definition of volatility perfectly
Markets are reacting very sensitively to investors’ emotions. Good or promising news about COVID-19 (definitely not about the economy) triggers market rallies, while discouraging infection or employment numbers cause the opposite. These reactions can be a mere single day apart, during which time the actual situation didn’t change one iota; however, investors’ reading into the stats is amplified in this hyper-sensitive time we live in. Intra-day volatility is at an all-time high, as well, with markets showing one direction early in the day and reversing the trend towards the day’s end. There quite simply is no reliable pattern.
Investors priced in their fears of economic collapse through March and into April. Since then, markets have responded to encouraging, yet unconvincing, news regarding the “flattening of the curve” in many jurisdictions (Ontario excluded). As statistics relating to unemployment, housing, bankruptcies, and the like start to pour in over the next few days or weeks, some analysts expect markets to slide once again, resulting in what’s called a double bottom, or “W” pattern stock market. Other analysts point to economic indicators and past market experience, particularly that of the period 2007-2009, to argue that the bottom was reached already in late March, and that we will witness more of a “V” pattern stock market, albeit a shorter one than 08-09. The one thing most analysts seem to agree on is that nothing is certain other than continued volatility, whichever pattern prevails.
In these volatile markets, when many investors have lost value in their investments, there are still a number of things you can do that could potentially provide more protection, take advantage of the conditions, and even possibly position yourself for a more robust recovery when it happens. Below are some ideas worth discussing with your financial advisor. If your advisor hasn’t brought these up yet (other than buying the dip, since that’s the one that benefits the advisor the most), then perhaps it’s time to talk to a new advisor.
Reassess your risk profile
If your stomach is churning and you’re losing sleep, or even if you’re not, now’s a good time to reassess your risk profile. Your risk profile is a qualitative category that takes into account your risk tolerance, investment knowledge and experience, investment philosophy, and your time horizon. It ranges from very conservative to very aggressive, but was likely assessed last when the markets and investments were more stable than today. So it makes good sense to revisit this and make sure that your risk profile in these times is the one you use to guide your investment decisions today.
Rebalance your investment portfolio
Each risk profile has a corresponding asset allocation, or mix of equity investments and fixed income investments. The more aggressive your risk profile, the higher the weighting of equity securities in your investment portfolio. Whatever your risk profile, it’s a good idea in markets like these to rebalance your investment portfolio to the asset allocation that corresponds to your current risk profile. This would ensure a level of volatility in your own investment portfolio that matches what you can reasonable tolerate – even in market conditions like these.
Buy and hold only quality
When markets are hot, it’s sometimes hard to tell between high quality investments and low quality investments. It’s when markets tank that the performance difference can become blatantly clear. You may see the contrast within your own investment portfolio. If not, contact an investment professional. Here are some signs to look for:
- Own what you know. Clueless about the mining industry in Canada? Stay clear. Still using that Canadian bank? Probably a better option.
- Check its track record. While past performance is not a reliable indicator of future performance, it may hint at whether this investment has, historically at least, been a good one to own. It also may suggest that, in the case of an investment fund, the investment is well-managed.
- Choose active management. Individual securities like stocks, bonds and exchange-traded funds (ETFs) are not actively managed investments. You, or your investment advisor, are the money manager, and it’s hard to know everything you need to know about each security you own. Most investment funds, like mutual funds and segregated funds, are actively managed by a team of professionals. They know each underlying security intimately and make decisions on which securities to hold based on economic indicators, monetary policy, fiscal policy, and performance requirements. For a glimpseinto the complex active management process, please read this piece, compliments of NEI Investments.
- Diversify. It’s generally viewed that a diversified investment portfolio outperforms a very narrowly-focussed portfolio, especially in volatile market conditions. Check out this fascinating table, courtesy of RBC Global Asset Management, on how different asset classes have performed relative to each other over the past decade.
Stay invested (unless you can see the future)
If you can’t see into the future and didn’t predict the precipitous market plummet back in March, you likely didn’t cash out your investments on February 20. Experts say that remaining invested is the best way to recover from a bear market, especially one that may see a quick return to previous levels. Why? Because we can’t know for sure when that recovery will begin and, given our obvious skittishness, we become sceptical that good days mean recovery and we are reluctant to re-enter the markets. The result: we end up losing out on the best days of that recovery, which tend to be at the beginning. Consider the following graph:
Resist withdrawing money
What we do want to try to do when the value of investments is low, is to resist withdrawing money from these investments, when possible. Of course, at times, we need to withdraw money. After all, that’s why the investments exist in the first place. However, drawing down on investments that have fallen in value could amplify those losses and make it harder to recover.
Buy the dip
You’ve heard it many times before – “Buy the dip!”. When investments plummet, as they have this spring, these securities are “on sale”. As long as you buy quality investments, you can reasonably expect that the prices of these securities will increase – providing you with a gain on the investment. Research by Manulife Investment Management found that if you buy into the markets after a 10% dip, you could see significant additional downside and it takes on average 730 days to break even. If, however, you wait until the market has dipped 30% (as it was in late March and into early April), you could break even in only 250 days.
Realize capital losses
Investment losses of any kind are hard to swallow. This is particularly true when you rely on these investments for current income, as is the case with a retiree’s RRIF. Some investment losses, however, could provide a future tax benefit down the road. If you hold non-registered investments – investments outside of an RRSP, RRIF, LIRA, TFSA, RESP or RDSP – taxes are applied on the capital gains on those investments when they’re sold for more than they were purchased. Conversely, when these same investments go down in value – below their purchase cost – there is an opportunity to realize a loss by selling them and replacing them with similar or identical investments. This “capital loss” can then be carried forward indefinitely and applied to a future capital gain to reduce the income taxes owed on that gain. Check with your financial institution to find out what your “book value” or “adjusted cost base (ACB)” is on your investments to determine whether you have a loss to realize or not. This is an absolute no-brainer for many non-registered investment holders.
Dollar-cost-average new money into equities
While many experts advise buying into the dip is a good way to potentially accelerate future investment gains, which securities you buy and how you buy them could make a difference in those gains. Typically, and in this very case, equities (stock-based investments) have fallen in value more than fixed income (bond, GIC, other debt) investments. So while your overall investment portfolio should hold both types of assets, it may be more beneficial to buy up additional equities at these low prices rather than fixed income. History tells us that it will be equities, also, that experience the greatest gains during a recovery, so as long as you have the time to see these gains to fruition, equities is where it’s at. Further, since we’re not sure if we’ve seen the bottom of the market yet, putting all of your new investment money into the markets all at once could prove costly in the short-term. Dripping the new money periodically, or when the markets have particularly bad days, could help protect the capital in the short-term while positioning yourself for accelerated gains in the medium- to long-term.
FOR RETIREES AND RRIF HOLDERS
Push your RRIF withdrawal to end of year
What you do with your RRIF income depends, partially, on whether you live off that income or not. If your other, more guaranteed sources of income (e.g. CPP, OAS, pension plan), sufficiently cover your expenses, at least for a few months, you may want to push out any withdrawal of income from your RRIF. This will give your RRIF investments more time to recover their value withdrawing money. The risk to this tactic is, of course, that when you do withdraw the money, you may be forced to take it at a time when the investments are actually lower.
Set RRIF withdrawals to monthly
However, if you do need your RRIF income on a more regular basis, try withdrawing on a monthly basis, instead of quarterly, or in one lump sum early this year. This will reduce each individual withdrawal when the markets and your investment values are low.
Reduce RRIF withdrawal
If your cash flow permits, take advantage of the current allowance to reduce your annual RRIF minimum withdrawal by 25%, for the reasons discussed in more detail above.
Supplement RRIF withdrawals with low-interest debt
With your RRIF down in value, your minimum withdrawal from your RRIF has also decreased at the same rate. Many retired Canadians rely on that RRIF income to make ends meet. This is particularly true if you have limited other sources of income and/or if your RRIF isn’t very big to begin with. For example, if you are 75 years old and your RRIF was worth $200,000 before the markets fell, your minimum RRIF withdrawal for 2020 would be 5.82%, or $11,640. That’s not a lot of money to live on. A 15% fall in the value of your RRIF would mean an equal reduction in your RRIF minimum withdrawal, meaning you would be required to withdraw $9894. It’s tempting to seek the additional $1746 from your RRIF; however, remember that we want to preserve the value of the investments as much as possible and push off additional withdrawals. So what’s the option? Consider a small loan. Ideally, this would be done through a low interest line of credit or home equity line of credit (not a credit card!). By resisting the additional RRIF withdrawal for one year to give the RRIF time to recover, your gain could potentially offset the interest owed on the loan, plus leave additional gain in your retirement savings. When you withdraw funds from your RRIF the next time, you can pay off the loan.
Hold 2-3 years’ of income in cash
You’ve heard or read me before touting the benefits of Balance Financial’s Three Bucket Strategy. Not since 2008 could this strategy be more beneficial to retired Canadians. Bucket #1 holds two to three years’ of income needs in cash – stability to provide you with the income you need long enough for your investments to recover. When we say two to three years of income needs, we’re referring to the additional income over and above your other income sources (e.g. CPP, OAS, pension plans). So, for example, if you need $60,000 to live on and your combined CPP, OAS and pension payments amount to $53,000, you would hold $14,000 – $21,000 in cash. The hope is that by the time you run out of cash, the value of your investments could have recovered. What do you hold in Bucket #2 and Bucket #3?
Seek Professional Financial Advice
While we’ve tried to provide you with information on actions you can put into place today to help your investments, there is no substitute for honest, comprehensive professional advice. Speak to your financial advisor to help you navigate these volatile times, or call us and we’d gladly provide you with free advice with no obligation.
Please stay well.