Here we are at session number 71 , and we’re going to be talking about how to keep your head in a financial crisis. There are few skills more important to financial success than learning to focus on the longer term, even when the short term looks pretty hairy. In this week’s show I’ll look at this in detail so you’re armed the next time a blip in the markets threatens to derail your plans…
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But first…
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Introduction
It’s six years now since the worst of the Credit Crunch and the financial meltdown that came with it. I remember watching with amazement the headlines that were published in the press at the time. It wasn’t uncommon to read things like “Meltdown!” “Armageddon!” and “Crash”. When you watched the BBC News, reports on the financial crisis were always accompanied by graphics of downward pointing red arrows crashing through the floor.
They say the only news is bad news, and it sometimes does seem like the media squirms with delight when something truly catastrophic happens. But even everyday blips in the market seem to blown out of all proportion by the media.
The problem is, we’re forced to consume this negative information and no matter how guarded we think we are, it does sink in.
Everything you need to KNOW
So, let's deal with everything you need to know, to protect yourself against the barrage of negativity:
1 – There’s no such thing as an unbiased source
I don’t know about you, but as I have grown older I’ve definitely become more cynical. I suppose that’s natural, but I have definitely got to the place where I distrust many institutions, and that definitely includes the media. My default position is to trust people, and I don’t ever want that to change, as it makes for a pretty miserable life if you’re always mistrustful of every one around you.
But big corporations, governments and media outlets are all targets for my cynicism. Not because I think there’s inherent malice in any of them (there’s that trusting soul again) but because I know that humans are basically self-serving and self-preserving, and wherever we gang together in a body corporate, that trait tends to be amplified.
Fact is, everyone has an agenda of some kind, even the news outlets. Some of them wear this agenda very openly, like the hilarious Fox News in the US. Most of them assume a posture of militant independence – “we are the most reliable source of news and information on the TV/Radio or Internet.”
At the least insidious, the news outlets have an agenda which is to remain in business. For the commercial channels this means ratings as that in turn means advertising revenue. The “unique way the BBC is funded” should mean less of this bias, but it doesn’t seem to. I’m more aware now of the language used when reporting, or when an interviewer asks questions, and sometimes (often) I find myself shouting at the TV when a question is framed in such a way that the viewer forms an opinion before the person being interviewed even opens their mouth in response.
Anyway, time to step quietly off the soap box and put it to one side. Please understand, as I’m sure all of you do, that there is no truly unbiased, unfettered source of news and information out there, and filter what you hear accordingly.
2 – Financial planning is a long term game
The subtitle says it all. It is very rare indeed for any financial plan to be short term. The shortest plan I ever wrote was for a guy with terminal cancer. We planned for six months and he got three years and was able to see everything tidied up and set up for his wife before he died.
But for most of us, we’re planning for decades, not weeks or months. Even the planning I do for those in their late 70s right now usually has a timeline of several years.
When you’re planning so far out, we should call financial plans what they really are which is, at best, educated guesses. We have no idea what is going to happen in the future, so while we make assumptions in our plans, these must be constantly reviewed.
The length of the timescale of most financial plans means that the short term, makes very little difference, unless it is truly catastrophic, like a cancer diagnosis or unexpected divorce petition. But market movements? Meh, they’re up today and down tomorrow. But over time, we can invest in a way that is predictable over the long term…
3 – Timing the market vs time in the market
This is a lovely investing cliché but it totally works. For the most part, trying to time the points at which you invest or disinvest is a mug’s game.
It would be disingenuous to say that the time you invest doesn’t matter. Those of my clients who invested at the height of the market in 2006 before the credit crisis hit, had a harder time than those who invested in March 2009 when the market was at its bottom.
But over the longer term, the impact of that timing lessens. A prudent investor will review and adjust their plans regularly over time, but trying to second-guess the market by selling out and buying in is really dangerous stuff. There are all kinds of studies about the impact of missing (say) the best 40 days out of ten years of investing. There are fewer studies about missing the worst 40 days!
There is no way at all you can possibly hope to get those calls right though. The biggest issue I have found is when people may get the jitters and sell out because they feel like there is a dip in the markets coming but they never know when to go back in. I have one client do pretty well because he pulled mostly out of the market in early 2008 and spared himself some losses. But he waited until early 2010 to get back in, when the low point in the market was in March 2009. By dithering, he lost out on some significant growth.
Easy for me to say that though. He was less than five years from retirement and understandably wanted to protect what he had. But this was a smart guy and a very experience investor. He got it mostly wrong, and so would I, and so would you.
4 – Short term crises WILL happen
It’s a fact of life that crises will happen. Nothing goes perfectly smoothly. We had our office moved planned to perfection. We had juggled different tradesmen and had them overlapping so that the disruption was kept to a minimum. All went well with the move itself and the wiring and the building of two new partition walls, and the decorating of those walls and everything. Then BT left us without broadband for ten days. The most frustrating part about that was that no-one could do anything about it. Even the guy at BT was just waiting for an automated system to update but couldn’t do anything about it!
Maddening stuff I tell ya. And yet, people had told me to expect BT to let us down, and so it wasn’t actually a surprise when it did in fact happen.
So I’m here to tell you that financial markets do reverse. Unexpected illness do happen. Family changes are inevitable. When engaging in planning, it is essential to bear these in mind. You can perhaps model the impact that going into long term care might have, or losing one partner early, or being forced to retire earlier than planned. You can measure the impact of a couple of bad years in the markets too.
The point is that you can be prepared for these things if you know they will happen, and they will!
Summarise KNOW
#1 – There is no such thing as an unbiased source
#2 – Financial planning is a long term game
#3 – Timing the market vs time in the market
#4 – Short-term crises will happen
Everything you need to DO
So let's look at the practical steps which can help you ride out during a financial storm which might threaten to shipwreck other, less prepared investors. What do you need to DO?
1 – Have a plan
There are few things more comforting when setting out on a journey, then knowing the destination. Some people love the thought of getting on a plane and then just sorting out the accommodation and everything when they get there. That is so not me! I like everything in place before I set off and will check and double-check all details to make sure this is the case.
Few people like financial surprises though, except for a lottery win or unexpected inheritance maybe. There tend to be more negative surprises when it comes to money, usually borne out of not being sufficiently well prepared.
Dave Ramsey, in his book the Total Money Makeover talks about Murphy of Murphy’s Law, which says that what can go wrong, will go wrong. He says that Murphy is far more likely to take up residence if you don’t have an emergency fund, or if you’re in debt. Protection from Murphy comes to those who are prepared for his visits. Those who are really well prepared are totally unaffected when Murphy rolls into town.
Having a plan, and following it to achieve your own level of financial freedom is the first defence against being blown about by whatever the headlines are saying that day. If you know that your plan is laid out – as far as these things can be – for the next 20 years, what do you care what happens today or tomorrow, or this year?
A long-term financial perspective makes short-term market jitters irrelevant
2 – Understand the risks of everything you invest in
They reckon that knowledge is power. Perhaps that explains the explosion in information technology and the internet. Even this humble podcast is dedicated to educating the public on financial matters.
Knowledge is power when it comes to investing because if you know that if you are invested along a Balanced risk profile, and that someone invested in this way can expect year on year returns between (say) -10% and +20% then you’re not going to worry too much when the -10% year comes around. You KNOW that can happen. You KNOW that the good years always outnumber the bad years, given enough time, and you can relax and ride things out.
Those who don’t understand the behaviour of their portfolio, or who have cobbled together a bunch of funds with no structure and discipline (that’s most investors, but the way) do well to be worried when things turn ugly.
If, in 1999, you had a bunch of funds which while marketed as equity funds were, under the bonnet, very heavy in technology shares, you could have been sitting 80-90% loss by 2003. Ouch. But if you understood what was underneath the hood of those funds, you might have stopped to diversify somewhat and reduce the risk of the overall portfolio.
Understand the behaviour of everything you invest in. Study them carefully and know what to expect. That way you won’t be surprised or worried when things do get a bit hairy.
3 – Set long term benchmarks
Benchmarking is particular bug-bear of mine. When looking at a particular fund, the fact sheet will compare the fund, always favourably, with a benchmark of some kind. That might be the average fund in the sector it is in. Or it might be a composite benchmark made up of a couple of different indices, or it might be an off the shelf benchmark by some outfit like APCIMS or FTSE.
They are, however, next to useless on their own. Fund A might have outperformed Fund B, but if it took twice the risk to get there, then I’m not interested. There are lots of variables to take into account when comparing funds or benchmarks or whatever.
As you know, I advocate passive investing here on MeaningfulMoney, which reduces the disparity between funds because there are no fund managers to make good or bad decisions. It’s all about tracking style and tracking error and charges.
The only benchmark that really matters is the target you set for yourself. If when you are planning, you assume a 5% growth rate for the money you have, then that’s your benchmark. But don’t expect a 5% return every year – the world isn’t that predictable. Your portfolio isn’t a failure if you have a couple of negative years. You should allow a ten year window to see if your investment planning is correct.
The portfolios we use at Jacksons have ten year histories now and the assumptions have been borne out in every case. Not that I can take any credit for that, because we don’t run the portfolios – we outsource it. But how great to be able to show clients that the theory works, and has worked even through the worst financial crisis in 80 years – the credit crunch and ensuing Great Recession. When talking to new clients I can show them that if they are prepared to invest for the long term, we can be confident that our assumptions of return will be borne out.
The one year window might be miles off the returns hoped for, but a ten year window is the one that counts. Again, setting that long-term timescale reduces the impact of short-term jitters or bad media coverage of those jitters.
4 – Stick to the plan
This sounds obvious really, but investors’ biggest enemy is themselves. I know it is hard to trust a third party adviser, or some theoretical model of investing, when things are looking dicey in the markets. But remember – time IN the market is what counts. You can’t second-guess what is going to happen so you might as well hang in there, right?
The best way to derail the plan is not to stick to the plan. If the plan is done right, with conservative assumptions, decent risk profiling and intelligent investment, then there is no reason why you should abandon it just because things get bouncy in the markets.
Hold. Your. Nerve. Man up and ride it out.
If personal circumstances change, then yes, the plan should be redrawn taking into account the new parameters. Also, the plan should be reviewed every couple of years in the light of real life returns and compared with the assumptions made at outset. Is the plan being borne out in real life? Do tweaks need to be made?
But don’t panic and bail out half way through. That’s guaranteed to mess things up.
Summary
This session feels a little soapbox-y, so I’m sorry if that upsets anyone. I’m aware of the massive emotional connection people have with their future – that’s absolutely as it should be. That’s why having a plan is the best way to put some hard numbers and context on the emotions, in order to keep them in check.
Ignorance is a really bad place from which to make decisions. Informed, educated, well-reasoned planning is a brilliant foundation for taking control of your financial future. It’s your money. It’s your life. Will you grab it with both hands, or be wafted around by whatever the news of the day will be?
This week’s reviews
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News
Weight loss. Another pound gone this week, despite not doing much exercise. That puts me at 15 stone 13.5 lbs. Woohoo! That’s my short-term goal realised, which is that I wanted to be 15 stone something before I go on holiday. Check that one off with two weeks to spare!
I’ll be sending an email out shortly asking for a few people to have a brief phone chat with me. I’m looking to refine the LearnHowToBudget course that I am building over at LearnHowToBudget.com. Before I launch I want to make sure that I am covering all the bases and providing what people really want and need. So watch for that email, and if you’;re able to help me with a quick ten minute phone call, just mail me back.
Next Session Announcement
Next time we'll be talking about How To Retire Early. Now that’s link bait if ever I’ve seen it! If you have a question on this subject, or any other financial query that you want answering here on the show, then the best way to do that is to leave me a voicemail at meaningfulmoney.tv/askpete
Outro
That's it for this session of the MM podcast, I hope it was helpful. If I missed anything or if you have any questions, please leave them comments section below.
I hope you enjoyed this session. Thanks for listening – I'll talk to you next time.
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