One of the hardest parts about being a financial planner is convincing people to do things they’d rather ignore.
When times are good, it’s easy for people to avoid putting in place strategies that create some short-term work and discomfort in exchange for long-term benefit and security. That’s why crises like the current pandemic can serve as a valuable wake-up call, taking our advice out of the realm of theory and making it very real.
Estate planning is the prime example. People generally don’t want to think about their own death so they tend to avoid the issue and delay putting a strategy in place for as long as possible. One of my clients had been sitting on his will and other estate-planning documents for over a year by the time the coronavirus came along. Spurred by the all-too-real health dangers of the outbreak, the paperwork was quickly executed.
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Emergency Funds to the Rescue
Convincing people to put aside an emergency fund worth at least six months’ of expenses can also be a tough sell in normal times, too. But COVID-19 is turning out to be a very effective test case for why it’s so important to have a cash reserve, both in terms of providing security and opportunity.
A decade of robust economic and jobs growth since the 2008 financial crisis had caused memories to fade and bred some complacency that the good times would continue forever. Suddenly, widespread job losses, combined with stock market plunges, have provided a visceral reminder of why building a cash cushion is such a simple but powerful strategy.
Having enough cash to make it through at least six months allows people to feel a much higher level of comfort at a time of job cuts, pay cuts, furloughs, and a generally uncertain outlook. It also avoids the need to dip into investment portfolios during a down market or, worse, take costly early withdrawals from pre-tax retirement funds. Sure, the pandemic is also easing restrictions on required minimum distributions and eliminating penalties for those who need cash fast, but even with those incentives it’s not as if most people want to tap into their 401(k).
Beyond Security, Extra Cash Also Holds Possibilities
That much is fairly obvious. Less well understood is how a healthy cash reserve also provides opportunities to gain during volatile times. Contrary to what might be expected, most of the conversations I have had with clients during the worst period of market falls leading up to the March 23rd bottom — or what counts as the bottom up until this point at least — weren’t prompted by panic.
Many of my clients had come into this year wanting to deploy cash into the market but were wary of going all in due to concerns that the markets were reaching all-time highs and a correction was overdue. As a result, we helped them develop dollar-cost averaging strategies over 12-18 months to reduce their vulnerability to a downturn.
When that downturn came — more brutal and sudden than anyone expected — many of those clients reached out to us with a positive attitude, sensing opportunities for immediate action. With the market around 35% off its February highs at one point, some of them wanted to front-load their strategy to put more of their cash reserves to work.
This isn’t about pushing a more aggressive strategy on any client — dollar-cost averaging isn’t for everyone, and neither is it necessary to suddenly revise a well-laid strategy simply because of a shift in the macro environment.
These changes were simply the result of check-ins with those who’d already identified dollar-cost averaging as a strategy to accommodate their risk tolerance and to reaffirm their comfort level with their investment strategy in light of the current circumstances. For financial advisers, big market corrections are an opportunity to truly gauge a client’s risk tolerance. A client who was stoic about the idea of a 25% portfolio loss during an investment policy discussion may now be losing sleep as it happens in real life.
In our experience, clients are mostly holding steady with their current strategies or increasing their stock holdings. Of course, although the S&P 500 index roared back nearly 30% since March 23rd, there’s no guarantee it won’t retest its lows and fall further in the coming months. But unlike in the depths of the 2008 financial crisis, people see a clearer end-game to the pandemic, even if there are difficult days ahead.
The Bottom Line on Cash Reserves
The advantage of having cash reserves at times like this is not about being able to time the market bottom, which is outside of everyone’s control. It’s about peace of mind and the flexibility to invest in a way that takes advantage of opportunities in line with your risk tolerance. Having cash on hand gives an additional element of malleability to build strategies around dollar-cost averaging, asset allocation and risk exposure.
Those are the things that are actually within our control during the moments when it feels like nothing else is.
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To maximize what you can collect, it’s crucial to know when you can file, how delaying filing affects your checks and the income limit if you’re still working.
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