History Rhymes, But It Never Repeats Itself Part II

Two years ago, during the initial days of the pandemic, I woke up early one Saturday morning with a million thoughts racing through my head. In an effort to bring some order to what felt like an increasingly chaotic world, I penned History Rhymes, But it Does Not Repeat Itself. This article identifies 10 actions an investor could have contemplated to capitalize on the unique situation at hand. I am time and time again astounded by the unanticipated second-and-third- iteration effects of the pandemic. Twenty-four months later, I thought it would be insightful to revisit my recommendations and consider, broadly, what advice remains relevant — and what is less relevant — for investors in 2022.

Evergreen Advice

As broadly relevant to investors in 2022 as in 2020.

1). Assess Liquidity Needs: We recommend having two years’ worth of spending needs (net of portfolio yield) accounted for in cash and/or high quality short-duration bonds so that all living expenses, tax obligations and capital commitments are accounted for with confidence.

Now, more than ever, insulating your cash needs is the single most effective risk management tool of which I am aware. This strategy enables investors to hold on during the roller coaster ride of the markets and buy-in when assets look attractive. Though the prospects of inflation at the moment generate a cost for holding cash, it is the price one pays for financial security — and it is a fair tradeoff in light of the benefits for sure.

2). Walk the Walk: The stock market is the only place where assets go on sale 20-30% and clients run for the door — How about putting cash to work in markets broadly?

Warren Buffet famously advised investors to be: “fearful when others are greedy, and greedy when others are fearful.” For those with a long time horizon, buying when stock prices are low and selling when they are high is a counterintuitive — but effective — move. Amidst the sociopolitical and inflationary volatility we are seeing at present, ask yourself the question…two years later have you learned and adhered to this lesson, or not?

3). See the Facts, Don't Rely on Emotion: There is always good news to accompany the bad.

It is always important to study the data. Two years ago, inflation was muted, stocks were reasonably priced by most all valuation metrics, and health issues were the circumstances of the day. Today, markets face geopolitical conflict and high inflation. As we describe in our wall of worry chart, there is always something to worry about in the markets. By the same token, there are always opportunities to tweak your portfolio to maximize profits. Some positive news in the market is that the cost of borrowing is still very cheap — though rates are rising — and unemployment in the United States is exceptionally low at present.

4). Affirm Your Risk Tolerance: Research shows that the pain of losing money is at least two times stronger than the satisfaction of an equivalent gain. Are you more, or less, tolerant of volatility than you say you are?

Like a Myers-Briggs Type Indicator or comparable assessment, metrics, like our preference for risk, rightfully and naturally evolve over time. Individual views on the market have been on a rollercoaster the last two years: we have traveled from pandemic lows to inflation highs. Have your feelings surrounding risk changed? If you’d like to gain more insight, consider using a tool to evaluate your risk tolerance so that you may calibrate your portfolio accordingly. This is a crucial part of our onboarding process, and if you are a client, we encourage to reach out if they’d like to be re-evaluated.

5). Remember What Money is for: As the economy ebbs and flows, financial goals provide direction and purpose for money.

Defining your goals remains a crucial exercise — this sets the stage for all other decisions.

Situational Advice

Strategic for investors in a broad sense during 2020. Always relevant for individuals on an as-needed basis.

6). Refinance: There has rarely been a better time to refinance your house, business, existing line of credit, etc. Focus on improving your own cash flow and do it now!

A rainy-day fund is always a good idea, as I mentioned in #1. Refinancing provides the opportunity to make an unproductive asset productive through borrowing capital at a cheaper rate. At the beginning of the pandemic, the huge sell-off in the market provided extremely low rates and thus an excellent opportunity to refinance. In fact, I practiced what I preached and took out a home equity loan (HELOC) on our primary residence. Already accretive, as rates rise and inflation kicks up, this will pay off even further.

7). Buy Low / Sell High: consider selling bonds at a profit now and either shortening their duration or rotating into any number of oversold asset classes across the spectrum.

This would have been very profitable action as markets have rallied hugely; however, it would be difficult to replicate this in current markets.

8). Tax Loss Harvest: Take advantage of this sell-off to incur tax losses without adjusting your portfolio goals by swapping out index funds.

This was a fleeting window for a very powerful opportunity. When markets corrected more quickly than any technical Bear market in history (defined as down over -20% from the highs), investors who nimbly swapped out of positions into comparable instruments and thereby stayed invested while generating losses outside of the Wash rules to offset against future gains were able to generate meaningful tax savings that help save real money when taking profits into 2021 and 2022 alike.

9). Gift Shares: For estate or wealth transfer strategies, now is an ideal time to gift large number of shares at temporarily depressed prices, especially hard-hit sectors or people with concentrated positions. With annual gifting at $15k individually ($30k collectively), this can really add up.

Of all the techniques suggested I think this was probably the hardest to execute amidst the quickly-moving markets. Succinctly, you could do just as much if not more with public, marketable liquid gift instruments at a fraction of the complexity.

10). Hedge: Consider Puts to profit if the markets decline or Calls that will increase in value if the market rallies. If neither scenario unfolds you are only out the money you incurred to buy the Call or Put.

Amidst the uncertainty of the pandemic low, some investors may have sought security buying puts or calls. Of course, these actions have merits and costs. To protect your portfolio, you must be willing to pay. If you really think something is undervalued don’t be afraid to buy a call on it — but don’t confuse the goals with your actions and be upset if your protective puts are not warranted or the upside from your calls does not come to fruition. You cannot have it both ways.

Conclusion

While no decision will give us complete certainty, we can instead strive for clarity. Clarity comes from measuring our actions in a candid, non-judgmental fashion, and it helps us improve in the future by learning from our mistakes and our successes. In fact, I like to think of mistakes as learning experiences. And while I hope we wave goodbye to the pandemic as soon as possible, I would be remiss if I did not say it would be an even greater tragedy were we all not individually and collectively able to learn from it for the better of us all.