As we embrace a new year full of new possibilities or simply getting back to a more normal existence, it's a great time for advisers and their clients to take a step back and reflect on what’s been learned in 2020. From a financial perspective, the experience of the past year has taken what is often theoretical and made it a reality for many.
Learning from these very recent lessons and taking action to improve their retirement planning to achieve a better retirement future can and should be a key focus for advisers in 2021. Here are five resolutions for the New Year.
1. Learn from 2020: Always prepare clients for emergencies. No one could have predicted the way the pandemic has created financial challenges for so many households, making it difficult for many clients to maintain the recommended three to six months' worth of total living expenses in cash for use in emergencies so that investments can stay the course.
Our research suggests that an employer-based retirement plan is the only place that a majority of workers are actively saving, so it is no surprise that almost 6% of workers who were affected by COVID-19 last year had to tap their long-term investment strategy in their DC plan — taking advantage of the CARES Act provisions — and potentially derailing their retirement strategy.
2020 was a wake-up call for many investors on how important having an emergency reserve is — to establish, and maintain over time.
2. Invest, invest, invest. Once investors have set aside an emergency reserve fund, holding excess cash out of fear of investing in the market means you are losing ground. Is it better to recommend clients invest it all at once or dollar cost average so they may feel "safer?"
History tells us that markets spend more time rising than falling, and even with periods of sideways movement, the ability for the index to grind higher has meant more reward to those using lump-sum investing over dollar cost averaging. In fact, 66% of all monthly S&P 500 returns going back to 1990 have been positive -- allowing lump-sum investing to consistently outperform. Over time, for example three- or five-year holding periods, lump-sum investing outperformed dollar-cost averaging almost 75% of the time.
While dollar-cost averaging may remove the emotion from investing, not only has lump-sum investing been proven to consistently outperform, but advisers and their clients should also consider that in the current low-interest rate regime, cash has a real negative yield, leaving them penalized for holding large amounts of cash while they dollar-cost average.
3. Stay calm, stay invested. Our 2020 Guide to Retirement outlined the impact of missing out on the best days in the markets, comparing the returns of a $10,000 investment in the S&P 500 over the past 20 years, which clearly highlighted the benefits of avoiding the temptation to pull out of the market and risk missing the days with greatest gains.
If we look at market swings in recent times, however, 2019 saw six of the best days occur within two weeks of the worst days. This trend has been even more pronounced in the COVID-19 impacted markets of 2020, when that number has risen to seven, with five of those best days occurring within just one week of a worst day. Overwhelmingly the worst days occur before the best days.
On many occasions, our analysis shows that the worst days are followed the next day by one of the best days, meaning it’s literally impossible for an investor to reinvest in the market if they’ve pulled out after experiencing a poor return.
4. Minimize tax bills through diversification. Just as no adviser will recommend clients put all their money into one asset class, investors also shouldn’t save and invest all of their money in the same tax-type account when planning for retirement. Having healthy income tax diversification — taxable, tax-deferred and tax-free (Roth) provides greater flexibility in retirement when constructing a retirement income plan.
In retirement, it’s critical that advisers help clients understand the impact of tax-deferred withdrawals, how much the Social Security benefit will be subject to income taxes, and potentially extra premiums for Medicare coverage. If clients are concentrated, advisers should consider recommending saving into a Roth option or converting a portion to achieve healthier diversification.
Lastly, investors should consider the Tax and Job Cuts Act’s relatively low federal tax brackets that will sunset after 2025 — this creates a window to both contribute and potentially convert tax deferred assets at a lower cost.
5. Spend less, save more. For many, 2020 caused a drastic shift in spending behaviors — in April alone, we saw an overall reduction in spending between 20% and 50% depending on wealth level for both steady earners and retirees. While this pullback was driven by stay at home, now is the time for clients reflect on what they want their spending priorities to be going forward as things normalize.
Investors can put this into action by increasing their retirement plan contribution, committing to save more through an auto-escalation option or "paying themselves first" by moving some income from their bank account once it arrives into savings or a diversified investment strategy.
Katherine Roy is chief retirement strategist at J.P. Morgan Asset Management.
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