As an investor, are you in the accumulation phase, or the distribution phase? This important distinction makes decisions on how to invest your money easier and makes volatile markets more navigable.
The COVID-19 pandemic has created significant uncertainty for investors in 2020 and has left many wondering how their retirement accounts will fare. Paul Hood, president and founder of Hood and Associates CPAs, has a simple solution for guiding his clients through these uncertain times and notes that if your investment plan is properly set and managed, fluctuations in the market can be harnessed for your benefit if in the accumulation phase of life or mitigated if you are in the distribution phase.
“We know people are scared,” Hood said. “Don’t make investment decisions based on fear or based on greed, make them based on a comprehensive plan to either minimize or transfer risk, or to take advantage of risk depending on which phase of life you are in.
The first step to forming a comprehensive investment strategy is to categorize yourself in the accumulation phase, typically for younger investors trying to significantly increase their worth over time, or the distribution phase, typically for older investors nearing retirement who need to minimize risk on healthy accounts.
“In the accumulation phase, risk and volatility is our friend. If the market goes up, ‘yay’ our investments make money. If the market goes down, double ‘yay’ because we’re buying things on sale,” Hood said.
This philosophy is contrary to many investors’ instincts. When the market is down, most will sell off stocks and get more conservative with their investments, but this takes unrealized losses and makes them real. Hood quotes Warren Buffett as saying “the stock market is a great place to transfer money from impatient people to patient people.”
Hood advises clients to use Dollar Cost-Averaging, which is defined as dividing a total investment across periodic purchases of a target asset in order to reduce the impact of volatility on the overall purchase price. By buying on a systematic basis you can harness volatility by lowering your average cost basis.
The second phase of investing, the distribution phase, occurs when an individual begins taking money out of accounts, or stops putting money in. During this phase, the key is to mitigate or transfer risk, which requires an overhaul of their portfolio and way of thinking from an account value standpoint to a cash flow analysis.Hood says “This phase in life is where most financial advisors fall short. Simply getting more conservative is no longer the answer. Transferring risk of running out of money and mitigating risk of having to sell depressed investments when you need a monthly check by segregating funds needed for distributions according to a predetermined plan will soften the impact of market fluctuations.”
For Hood, that means creating three separate portfolios with clients.
The first portfolio is conservative and holds one to two years’ worth of income needs, which provides stability through typical market corrections.
The second portfolio is moderate in terms of risk, and the third is a small, aggressive portfolio used to stay ahead of inflation.
Using this setup, clients can mitigate risk because they don’t need to sell when the market takes a downturn and prices are low.
Through all of the turmoil of recent months, which Hood notes is not solely due to the pandemic, but also involves other factors including the upcoming presidential election, Hood has consistently advised clients to ignore the fluctuations in the market and instead focus on the strategy he’s outlined.
For those who have been advised to be conservative and stand pat over the past few months, “you need to call us” Hood said.