The final quarter of 2018 had the feel of the highly volatile first quarter. The year began with enthusiasm as lower taxes sent stocks to all-time highs. This euphoria quickly subsided and morphed into a rapid 10% correction. Entering the fourth quarter, major U.S. stock market indices had reached new all-time record highs, only to finish the year with another round of gut-wrenching declines which left a mark on both client’s assets and their psyche.
Wild price swings are uncomfortable even for the most seasoned investors. Heightened volatility came from many sources. This time the list included higher short-term interest rates, the Federal Reserve’s tightening monetary policies and hawkish comments, potential for an inverted yield curve, trade tensions between the U.S. and China, a government shutdown, slower global economic growth, falling oil prices, politics and simple old-fashioned fear. Solid economic fundamentals did not deter this quarter’s painful price correction. Stocks largely went into freefall from highs set in September. The NASDAQ Composite, S&P 500 and the Dow Jones Industrial Average lost 17.3%, 13.5%, and 11.3% respectively in the fourth quarter. The high flying “FAANG” stocks that carried the markets to new highs over the past nine years were hit hard. Amazon, Apple, Alphabet (Google), Facebook and Netflix experienced quarterly declines between 13.4% and 30.6%. International stocks also struggled as the MSCI EAFE and emerging markets indices produced losses of 12.5% and 7.5% for the quarter.
When stocks fall, bonds usually provide some portfolio relief. Investment grade and treasury bonds did just that in the quarter. Despite a fourth 25 basis point rate hike to the fed funds rate this year, the Bloomberg Barclays Aggregate Bond Index managed a positive 1.6% return for the quarter. Unfortunately, high yield bonds suffered along with stocks, declining 4.5% in the fourth quarter.
We always discuss the importance to remain focused on your long-term financial goals. A sharp correction, like the one just experienced, creates fear. If left unchecked, fear will cause well-intended long-term investors to sell low and buy back at higher prices. It takes courage and commitment, but it is important to avoid this very-common investor pitfall. Staying the course in the face of fear is challenging but necessary to achieve your long-term objectives. The pain here is real, but time will eventually heal these wounds.
HOW TO BEST RESPOND TO VOLATILE MARKETS
Although market fluctuations may be unsettling, it is important to not let short-term price swings distract from your long-term strategy. While the temptation to shift course in the midst of market volatility is common, a better strategy may be to do the opposite. As long as your asset mix accurately reflects your financial goals, time horizon, and risk tolerance, sticking to your investment plan could prove rewarding over time. And, in fact, decreasing your equity allocation for fear of losing money could put you at greater risk of running out of money in retirement.
FOCUS ON THE LONG TERM – The short-term factors affecting stock prices can be difficult to determine. Over the long term, however, stock investing has provided a way for individuals to share in the growth of the world economy. Consider the returns of a hypothetical $100,000 investment in the Bloomberg Barclays U.S. Aggregate Bond Index versus the S&P 500 Index over the same 25-year time frame ending December 2017. If the assets had been invested in an all-bond portfolio, the value would have grown to about $379,510. If it had been all in stocks, on the other hand, the account would be worth about $1,009,880 – a substantial difference.
BUILD YOUR PORTFOLIO –Your allocation should reflect your investment horizon – the time remaining until you begin to withdraw the money and the amount of time it will take to spend it – as well as your risk tolerance. The appropriate allocation for your portfolio can help maximize your growth potential without exposing you to inappropriate levels of market risk for your time horizon. In general, the longer your time horizon, the more you should have in stock funds or other growth-oriented investments. An investor who can wait 15 years or longer to begin drawing on his or her investments might consider pursuing growth through a portfolio of mostly stocks. On the other hand an investor who plans to start drawing on his or her investments within 10 years might consider a portfolio of 60% stocks, 30% bonds and 10% short term investments (such as cash or a money market investment).
Whether you are developing your first investment plan or reviewing an existing one, avoid the temptation to time the market – making a decision to buy, hold off on buying, or sell – based on recent market performance. History shows that attempting to do so can undermine an otherwise sound investment strategy. Investors who try to time the market tend to enter and exit the market at the wrong times. It’s very difficult to time the market because the market’s behavior is far too complex for anyone to anticipate. Investors may get out of the market thinking they’ll avoid a downturn, but instead end up missing gains.
Market rallies can happen quickly. If you choose to sell equity holdings following a decline, you risk missing out on the potential for a powerful initial surge. Moreover, if you pull out of the market and happen to miss some of its best days, you may miss out on the recovery altogether.
2019 CHANGES TO THE HARDSHIP WITHDRAWAL RULES
The Bipartisan Budget Act of 2018 has made several changes to the hardship withdrawal rules, under 401(k) and 403(b) plans, that will become effective on the first day of the plan year that begins in 2019. The legislation:
Amends Section 401(k) of the Internal Revenue Code to allow distributions of qualified nonelective contributions (QNECs), qualified matching contributions (QMACs), and earnings on elective deferral contributions, QNECs and QMACs (these changes will not apply to 403(b) plans unless corrective legislation is enacted) as a hardship withdrawal.
Directs the Treasury to update its 401(k) safe harbor regulations to remove the required six month suspension of deferral and employee contributions after receipt of a hardship withdrawal.
Amends Section 401(k) of the Internal Revenue Code to allow hardship withdrawals without regard to whether participants have first obtained available plan loans.
The second and third changes will also impact 403(b) plans using the 401(k) plan safe harbor test. None of these changes impact the rules for unforeseeable emergency withdrawals from 457(b) plans.
We are currently awaiting official guidance from IRS as these changes are effective January 1, 2019 for plans with a calendar year-end.