The COVID-19 pandemic has been one of the most trying periods for society in generations. Restrictions meant to curb the spread of the virus led to devastating job losses, the closure of small businesses, and for a lot of people, a transition to a new way of working, learning and living at home. The government and the Federal Reserve have stepped in with unprecedented and unfathomable levels of financial market support, financial aid and consumer financing to help keep companies and families afloat, but not everyone has come through the pandemic on equal footing.
Financial planning has always been critical in defining goals for your money and implementing strategies to achieve those goals. At Heritage Capital, we believe that comprehensive financial planning plays an even more important role following challenging times, as you prepare for an uncertain future. How will you recover from a temporary decline or loss of income? Are you prepared for the next unforeseen downturn? Can you restart a retirement savings strategy that may have been put on hold?
As we embark on the path to life post-COVID-19, the team at Heritage Capital has identified several factors to keep in mind while you map out your future.
For years, financial planning consisted of meeting with a stockbroker, who would assemble a portfolio of individual stocks, bonds and high-fee or commission mutual funds. Selling these investments to you usually earned the broker a commission but came with no obligation to watch out for your interests. In other words, there was no fiduciary obligation. Over the last several decades, investors have turned to financial advisors for help, as they take a more hands-on approach to their finances, and investor choices expanded beyond commissions to paying a fee for services.
Financial planning has continued to evolve, mostly for the benefit of investors. The experience of COVID-19 has highlighted the important role a financial advisor can play not only in maintaining a sound financial plan and investment portfolio but also being available to answer the many questions that may arise when your world gets turned upside down. It is this high-touch element of the advisor-client relationship that we believe is a key differentiator in financial planning going forward.
Pension plans, also known as defined benefit retirement plans, were the standard retirement source for workers at most companies and public employers until the 1980s. With pension plans, the employer was responsible for saving and investing to fund their employees’ retirement, determining retirement benefits based on their years of service and final salary.
Due to rising and unsustainable pension burdens and workplace savings legislation, companies began to pass on the risk and responsibility of saving for retirement to their employees through 401(k) plans. A 401(k) and similar workplace retirement plans are known as defined contribution plans because it is the worker that funds their own retirement through payroll contributions.
These plans can be complicated, and with the responsibility now on the worker, your financial future in your hands. A 401(k) plan must offer options for safety, income and growth. Usually that means a lineup of investment choices consisting of stock, bond and money market mutual funds or ETFs. Some plans provide more sophisticated investment choices and a level of financial guidance on retirement investing, but by and large, the 401(k) is a do-it-yourself savings vehicle.
Workplace retirement savings can be supplemented by other income sources such as private savings and Social Security. Keep in mind, however, that Social Security replaces only a percentage of your pre-retirement income, as determined by your lifetime earnings and when you start receiving your benefits. Everyone’s situation is different, and therefore, mistakes can be easy to make.
For years, the standard advice offered to investors was to buy a basket of stocks and bonds issued by well-known companies and hold them until you reached retirement or a similar financial goal. Mutual fund companies handed out colorful brochures with “mountain charts” showing how investing $10,000 at a certain date and holding them for the next 30 years would have your assets climb to new heights. While a buy-and-hold strategy can make sense for investors with a long-term horizon, this one-size-fits-all approach can leave a lot of money on the table, because everyone’s situation is different.
Better and more accessible investment research, an improved understanding of risk and return as well as investor behavior, along with a proliferation of new investment products has advanced investing to a greater level of sophistication and efficiency. The financial advisors at Heritage Capital have many tools at our disposal to closely analyze the risk of an existing portfolio and even project the performance of a simulated portfolio. Better education should more effectively highlight the value of risk management in protecting as well as growing your assets and lead to better investment decisions. Allocations can now be diversified and customized across more focused investments among stocks, bonds and alternative investments.
But progress can also create new problems. The use of derivatives strategies among individual investors as well as wealthy family offices and hedge funds increased during the COVID-19 pandemic, leading to some big gains but also punishing losses. Working with a financial advisor experienced in the prudent use of such investments can help ensure you take advantage of today’s changing investment landscape.
One of the byproducts of the historic fiscal and monetary stimulus pumped into the economy to combat COVID-19 is the return of inflation risk. Inflation has been mostly dormant for the last decade but inflation has been building since the second half of 2020, and the trajectory of rising prices could become troublesome. Input costs are up across the board. Labor shortages could be another spark that sends inflation to a level that causes the Federal Reserve to act on interest rates much sooner than currently projected.
Another X-factor to keep your eye on is tax policy. New spending is expected to be funded by higher marginal income tax rates for the highest earners, while a more-than-doubling of capital gains tax rates has also been proposed. Even if these efforts to raise taxes fall flat in Congress, the mere threat could sour sentiment and induce bouts of market volatility.
Perhaps the best benefit of financial planning is anticipating potential roadblocks before they appear and accounting for them in how investments are allocated and cash is managed. Working with a fee-based fiduciary financial advisor who embraces holistic planning can help neutralize your worst behavioral impulses.
While COVID-19 has changed the planning and investment landscape in many ways, it has not eradicated bad financial habits. From a retirement planning standpoint, these hazardous moves include cashing out of your retirement plan ahead of the legal retirement age of 59-½, which will generate a big tax bill plus a 10 percent early withdrawal penalty. Taking loans from your 401(k) can also hinder your ability to stay on an effective retirement savings track, subject you to double taxation if you pay the loan back with after-tax dollars and come with administrative fees.
Whether investing for retirement, a new home purchase, college tuition or a similar goal, being overconfident or too aggressive can also lead to trouble. The prodigious recovery of the stock market from COVID-19 lows has made investing seem easy to some, but the next bear market could be right around the corner, and no one has yet designed a crystal ball to ferret out these market moves ahead of time. Having your portfolio over-weighted to high-risk equities when you need the money to live on in less than a few years is akin to gambling: You could hit the jackpot, but you could also lose a major portion by not paying attention to and managing volatility.
On the opposite end of the spectrum, conservative retirement investors and savers may not realize the damage that can be done to their long-term goals by failing to take advantage of the long-term growth potential of stocks. Owning a portfolio of bonds and cash may help you sleep better at night, but it could fail to appreciate enough to cover living expenses well into the future, especially if inflation resurges.