The Impact of Recent Market Volatility on Financial and Retirement Planning

The Impact of Recent Market Volatility

on Financial and Retirement Planning

August 2020

Aging and Retirement

The Impact of Recent Market Volatility

on Financial and Retirement Planning

Caveat and Disclaimer

The opinions expressed and conclusions reached by the author are his own and do not represent any official position or opinion of the Society of Actuaries

or its members. The Society of Actuaries makes no representation or warranty to the accuracy of the information.

AUTHOR

Toby White, Ph.D., FSA, CFA

Associate Professor of Finance and Actuarial Science, Drake University, [email protected]

CONTENTS

Introduction and Recent History ............................................................................................................................... 4

Financial Advising Impact .......................................................................................................................................... 4

Client Behavioral Impact ........................................................................................................................................... 5

Investment Transaction Impact ................................................................................................................................. 5

Asset Allocation Impact ............................................................................................................................................ 6

Conclusion / Future Direction ................................................................................................................................... 6

Personal Statement .................................................................................................................................................. 6

About The Society of Actuaries ................................................................................................................................. 7

The Impact of Recent Market Volatility

on Financial and Retirement Planning

Introduction and Recent History

On February 20, 2020, the DJIA (29,220), NASDAQ (9,751), and S&P500 (3,373) were near their all-time highs,

despite the looming global COVID-19 crisis. Barely one month later, on March 23, the DJIA closed at 18,592 (down

36.4%), NASDAQ closed at 6,861 (down 29.6%), and the S&P500 closed at 2,237 (down 33.7%). However, by June 8,

these indices had recovered the majority of their earlier losses (DJIA up 48.3% to 27,572, NASDAQ up 44.7% to

9,925, and S&P500 up 44.5% to 3,232). By July 31, despite a second wave of the coronavirus spreading throughout

the U.S., the markets had remained mostly level (relative to June 8), with the good news of a pending vaccine and

improving employment figures counteracting both poor quarterly corporate earnings and negative virus-related

trends.

The market volatility observed in 2020 was unprecedented in recent times, with the exception of the financial crisis

of 2007-2009. For most clients, their 1Q20 investment reports were as poor as they had ever seen, whereas if they

stayed the course, their corresponding 2Q20 reports (relative to 3 months earlier) were surprisingly stellar. Still, the

prolonged atmosphere of fear and anxiety has created ripples throughout the financial services industry, and

financial advising and retirement planning in particular. Here, we focus on how the role of financial planners has

been impacted through these wild swings, with special attention given to clients who are approaching or are at

retirement ages. In turn, we consider the impact of the pandemic environment on the role of financial advisers, the

behavior of their clients, the factors that induce investors to make trades, and any allocation shifts within individual

investment portfolios.

Financial Advising Impact

From late February through late March 2020, financial advisors were faced with an unusually high volume of

customer inquiries. When an agitated client calls in a time of potential crisis, the advisor’s first role is to listen and

attempt to quell the feelings of uncertainty and angst. The client may initially intend to exit the market or at least a

large segment of their portfolio, but the advisor will caution that selling off will lock in losses without the potential of

recovery. If the client truly cannot handle the elevated risk levels, and is comfortable with realizing sizeable

investment losses, the advisor will eventually acquiesce and satisfy the client’s request.

However, other alternatives are available, such as shifting the asset allocation of a portfolio, hedging positions that

are overly exposed, or adapting a wait-and-see attitude (if the client is not completely desperate for cash). A

seasoned advisor can draw upon their experience with handling similar concerns amid the recession of 2007-2009,

and remind their clients that the years that followed that episode of high volatility were some of the most favorable

in stock market history, with markets trending upward (with very low volatility) for the great majority of 2009 and

the 2010s decade. Financial planners must also avoid becoming overconfident in their supposed ability to time the

market or select individual stocks, as the majority of returns (positive or negative) in such times are governed by

macro-level effects that may be beyond the control of many individual firms or agents.

Client Behavioral Impact

It is quite difficult for the average American to avoid feeling fear and the resulting financial insecurity that

accompanies the current pandemic. News telecasts and printed media coverage remind viewers constantly of the

adverse health, psychological, and transactional aspects of the new normal. Many investors have lost access to a

source of their regular income, through reduced hours, going on furlough, or even having their jobs eliminated if

they are unfortunate enough to work for failing companies or within industries that cannot operate at full capacity

amid the economic slowdown/shutdown.

Some companies may be suspending retirement contributions into employee accounts indefinitely as a less painful

alternative to cessation of employment. Meanwhile, clients must continue to make house/rent payments, car

payments, bill/tax payments, and other potentially large periodic cash outflows. To satisfy these obligations, clients

may be forced to withdraw funds from their investment accounts, even at suboptimal times when prices are

deflated. Alternatively, they may also suspend periodic contributions into IRAs, Roth IRAs, and 401(k) plans. In

short, financial planners are likely seeing more outflow in the accounts they manage than inflow in 2020, which can

affect their compensation structure if based on volume of assets under management.

Investment Transaction Impact

Requests for financial transactions (among clients) are almost surely higher for most financial advisors this year than

in a typical year. It is fascinating to follow the financial news headlines this year, as almost on a daily basis, there are

wild swings in U.S. stocks and market indices that induce traders and/or clients to take action within their

investment holdings. Such swings may be caused by various governmental actions (Presidential announcements

about upcoming stimulus plans, interest rate changes by the Federal Reserve, or the degree to which the national

economy may be restricted or opened up due to pandemic spread management). Many large corporations are

frequently announcing forecasts or earnings that may be significantly different from previously expected. Any new

information relating to the efficacy and timing of a potential vaccine can especially sway investor sentiment for both

economic and health motivations, as can less optimistic comments from someone like Dr. Anthony Fauci.

For investors approaching, at, or just beyond retirement age, the ramifications of these changing conditions are

particularly paramount. The notion is that one has built up their nest egg over 30 or 40 years and is not about to

forfeit these gains due to something resembling a market crash. Those near retirement comprise a large share of

the highest-maintenance clients (and highest-income ones) that are most likely to keep their financial advisors up at

night. These concerns are elevated further if the client is forced to retire early (so that less income is available to

accumulate an adequate retirement fund), if there are major health issues within the family (among which could

include the virus itself), or if there is financial strain in the family (for which the retiree has agreed to assume the

burden). If there is a short-term need for emergency funds, especially when one’s liquid assets and banking

accounts are depleted, this dilemma may supersede any traditional investment considerations that would otherwise

exist.

Asset Allocation Impact

Many advisors, either with or without their clients’ permission, have taken the recent opportunities provided to

make asset allocation shifts to client portfolios. A common goal may be to minimize risk among the volatile

pandemic-era conditions, while preserving previous capital accumulation as much as possible. High-risk,

unpredictable sectors like International or Emerging Markets may be down-weighted until the economies

represented in such investments can be better understood. Furthermore, many investors have requested a shift

from stocks to bonds (especially Treasuries), or other assets (like certain commodities) that may be inversely or

lowly correlated with stocks and mutual funds. In other words, the benefit of diversifying one’s portfolio is greatest

in times of high volatility (like most of 2020). Some may even desire a significant share of their retirement funds to

‘sit on the sidelines’ in cash or cash equivalents for a few months or quarters, until markets stabilize again.

One interesting phenomenon is that growth stocks/funds, especially high-tech ones, have outperformed value

stocks/funds amid the crisis. This is counterintuitive, since historically, the value sector has suffered lower losses in

down/volatile markets than has the growth sector, while the growth sector outperforms in bull markets. In fact, as

of July 31, the NASDAQ is at/near its all-time high (10,745), more than double its value just before the dot-com crash

of early 2000. Since June 8, 2020, the date when extreme market volatility began to drop, until July 31, the

NASDAQ is up 8.2% further, while the S&P 500 is only up 1.2%, and the DJIA has retreated by 4.1%. Advisors may

also be applying hedging techniques more often than usual to minimize portfolio losses, while simultaneously giving

up the opportunity for large gains, at least in the short-term.

Conclusion / Future Direction

The most predictable aspect of the remaining months of 2020 is that they will be highly unpredictable. It would be

foolhardy to speculate on the future direction of financial markets, or whether the coronavirus will soon either

increase or abate in intensity. What is more certain is that these two phenomena are deeply intertwined, especially

for the financial advisory profession and clients who are aging and at or considering retirement. If health and

economic constraints allow one to have enough freedom to make unrestricted choices, perhaps a long-term view is

most recommended. In other words, instead of making drastic financial decisions that potentially overreact to the

temporary upheavals experienced recently, one might, cautiously but optimistically, make plans for the pending

upcoming return to normalcy.

Personal Statement

I became increasingly interested in financial planning topics during the Spring 2020 semester, when I taught

Personal Finance for the first time at Drake University. Almost exactly halfway through the term, the genesis of the

COVID-19 pandemic hit North America, causing Drake to send its students home early so that all classes after Spring

Break were online only. In fact, a circuit breaker shut down U.S. markets during the middle of one of our last in-

person classes in early March, for which my students, after checking their cell phones, informed me live. I would

like to thank Adam Schwallier who provided valuable perspective and insight on financial advice issues and

influenced many of my personal thoughts for this essay.

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