The Rollercoaster is Back. Time to Buckle in Your Financial Plan

silhouette of a roller coaster at a blue sunset during a fun fai

Weatherwise, March is known for variety, changeability, and extremes. That would make a good metaphor for what we saw throughout the month in essentially every area. The Russian invasion of Ukraine almost miraculously (if miracles are a function of human will and grit) was effectively stalled by Ukrainians. The damage is immense and ongoing, but what was a divided West is now solidly united against Putin. NATO is acting decisively, and individual countries are beefing up their commitment to defense and working on weaning themselves away from Russian energy.

On the home front, sanctions and further disruption of the supply chain are resulting in even more, no-so-transitory inflation, adding to the complicated and delicate job of the Federal Reserve. Fed Chairman Powell and his deputies have been open and transparent in communicating the pace of interest rate hikes to allow the stock and bond markets to avoid disruption.

The first rate hike at the FOMC meeting in March went off as planned. Less than a week later, Powell made remarks that the markets interpreted as indicating that rates may advance higher than previously thought, with 50 basis point increases at meetings instead of the more usual 25 basis points. After more than a decade of accommodative and “dovish” money supply policy, Chairman Powell and the Board of Governors’ goal now is to tighten the money supply to rein in inflation, promote price stability, and encourage maximum employment.

Now more “hawkish,” Powell has been citing the strong labor picture as his rationale for aggressive rate hikes, and the March employment number, out on April 1st, was no April fool. The unemployment rate fell to 3.6%, from 3.8%, as the economy added 431,000 jobs. For context, the unemployment rate hit a fifty-year low just before the pandemic, at 3.5%.

Where Does This Leave Investors?

Volatility does not mean you should cut back on investing; it just means thinking through the how and the when. If you get an annual bonus that you usually use to max out your retirement plan contributions, maybe hold off on that. Dollar-cost averaging will help you avoid the performance cost of making a significant contribution to your retirement plan and then having the market drop.

The amount you put in would then have to experience a market recovery to get back to breakeven instead of getting a performance boost from any market upswings. You want to be sure you hit the maximum investment, so give some thought to your contribution in each paycheck. Tax refunds are the same. If you usually invest some part of your tax refund, park the sum in a savings account and set up a monthly investment amount instead.

Do not neglect your education savings, though. If your kids are more than ten years from starting college, a 529 plan is the gift you give your future self. The savings advantage of having money at work is significant. You have no control over the future cost of college, except to know that it will cost more than it does now. You also have no way to avoid whatever the cost of money is when your kids get to college age, so every dollar that can come from savings lower the cost of any debt you or your child have to take out to fund education.

Think About Your Current Cash Flow and Tweak Your Plan

Inflation is going to remain high for some time in our belief. Even when supply chains stabilize and there is hopefully a peaceful resolution to the conflict in Ukraine, we are likely to see continued upward pressure on wages in the labor market as globalization is redefined by “onshoring” or “nearshoring” to protect critical parts of economic sustainability in the West – most notably chips, semiconductors, and energy. While it is unlikely we will see the complete unwinding of the last 25 years of globalization, there will likely be a recalibrating of the US and West’s interdependence on trade with Autocratic governments is strategically reduced to enhance economic security.

The pandemic was already having an inflationary effect on wage growth due to the “great resignation,” and the abrupt geopolitical events of the last six weeks may exacerbate and accelerate wage growth and prices on commodities adding to inflationary pressures.

The most optimistic outlook is that the Fed increasing the key short-term rate from the zero bound to 2.5% by year-end will potentially reduce inflation to 4%. There are no guarantees, and even that number is high.

So, your cost of debt will rise (most likely it already has – banks take the word for the deed and raise interest rates as soon as the Fed gestures toward higher rates), and at the same time, consumer prices will continue to be elevated. What will not likely increase as quickly is the interest banks are willing to pay you. Cash is always a critical component of your overall asset allocation and being able to meet short-term lifestyle expenses; however, maintaining too much cash in this environment can be detrimental to the achievement of your long-term goals.

A carefully constructed allocation to bonds (based on your preference for equity risk) is still useful to tamp down volatility in your portfolio and be a source of total return. However, we will continue to see volatile bond prices as the credit markets adjust to the current and expected rate of inflation. Bond durations should continue to remain short to guard against excessive price volatility.

The Bottom Line

The threat of the pandemic has receded, but now we are deep into a complicated unwinding of the programs put in place to help the economy recover. Your long-term financial plan should be crafted to meet your goals while taking the amount of risk with which you are comfortable.

At the same time, investing is not the same as having a comprehensive financial plan. Thinking through all of the issues you face, and ensuring that if you have a complex situation, you are giving attention to all the interlocking pieces, is even more critical as we enter a newly complicated reality.

At Columbus Street Financial Planning, we are passionate about working with clients to help them achieve their financial goals. Let’s do it together. Schedule a call with us today.