Normally I try to write something that is not tied to the news cycle on this blog. However, given the severity of the global pandemic, it seems like ignoring the elephant in the room if I don’t address it somehow. Maybe this will be a record of history when I look back in 10 years.
In the last 30 days,
- Global stock market (as measured by Vanguard Total World Stock ETF) has lost 30% of its value.
- The gas and oil prices have more than halved, which in turn decimated viability of many companies in the industry.
- US Federal Reserved slashed target Fed Fund Rate from 1.25% to ZERO.
- All major asset classes sustained a loss, including Bonds, Gold, and even Bitcoin, as companies’ need for liquidity (cash) spikes.
- US Government went from cutting budget to announcing trillion-dollar extra injection to save the economy.
There will be many more dramatic news to come. For example, how many people became unemployed, lost significant income, or accumulated debt from this crisis.
Short-term volatility like this occupies our attention. As the development of the pandemic and our immediate response to it take over our lives, it’s difficult to not going down the tunnel of one bad scenario after another.
This is how fear can take over. Hunker down, survival mode.
While we do need to take the immediate risk of Covid-19 to our health and our society’s health seriously, the science community has shown us that eventually the world will recover. This is not a pandemic that kills everyone it touches. Many will get sick, but most recover, even if not 100%.
The world will continue, but differently.
In my opinion, the time to be an alarmist has passed. The world should have been on high alert in early January. Now we are entering an escalating situation, it’s time to imagine a different future.
How will you live differently? How can we as a society function differently? How will the countries collaborate differently?
In other words, in the midst of continuing crisis, it’s time for us to adopt long-term thinking.
The best time for long-term planning
Since I’m a financial planner, I will give you a financial planning example on why in a market slump is the best time for long-term thinking.
In the field of retirement planning, there is a well-known variable called “sequence of return risk”. It describes the risk of withdrawing a fixed amount from your portfolio for expenses based on long-term average return during periods of depressed returns.
When everything is rosy
Here’s a simple thought exercise. Let’s say you enter 2020 with 1 million worth of stocks in your portfolio. You only need $40,000 a year to live. You consulted your statement and found that in the past, your portfolio had returned at least 4% a year on average. So you quit your job and begin to live on passive income.
Then your portfolio took a 30% hit in one month. That means today, you only have $700,000 in your account.
Nevertheless, you still need $40,000 to live. Even if the market stops dropping for the year, you’ll only have $660,000 going into 2021.
So in order for you to take $40,000 starting in 2021 without further depleting your balance, the market needs to return at least 6%.
What did you do wrong in this hypothetical scenario? You thought the long-term average of +4% return means you will have the same return every year, instead of 30% in one year, and -30% in the next.
In other words, if you had fell into a coma in 2019 and woke up in 2020, you would not have thought that you could retire. This is why it’s more dangerous to plan for the long-term when all things look rosy.
When it’s not
Let’s say in the second scenario, you had 1.5 million when you entered 2020. After a brutal year, you only have 1.05 million left.
You still only need $40,000 to live. In 2021, the market only needs to return below the +4% long-term average in order to provide you another $40,000 without further depleting your balance.
Now you realize that your portfolio value is enough to withstand some bad return years. It means that you may retire without worrying too much about how the market might move in the future. Planning for the long-term when things look bad give you a much clearer lens to see what’s needed when thing inevitably go bad again.
Caveat: I’m not saying 30% is as bad as it gets. As you know, last time we experienced this, the stock market dropped over 50% over 18 months period. This is also why for those close to retirement, 100% in stock is not a great idea – unless your spending need is low and portfolio value is high.
If the worst you are experiencing so far is being stuck at home with your loved ones, I encourage you to start thinking ahead for the next year and beyond.
What are the most important things you should focus on at every moment as you face the the mortality of you and your family?
How will you design your career, business, or income stream differently?
What have you discovered that was missing in your life? How can you utilize your resources to make it a reality?
What are the things within your control now that will put you and our society in a better position after we survive this?
The key is that you need to believe that we will survive the pandemic and its economic fallout. Recognizing the worst of it but still believing something better will come out of it. Even when we are looking for short-term solutions, we still need to be mindful of the long-term consequences because we will inevitably get to “long-term”.
Be cautious, but not fearful. We are in this together and will see each other on the other side.