Lessons from COVID

As I write this article on 23 March 2020, we are at what many are predicting is the beginning of the Coronavirus journey for Australia.

Already, the Stockmarket has seen a decline of over 30%. Many predict the worst is yet to come.

Cash looks pretty good in hindsight

Saving cash is a losing strategy over the long-term. With no capital growth, at best, cash barely keeps up with inflation.

But in the short-term, cash truly can be king. No capital growth comes with one major advantage - no capital loss.

A few years ago I had a goal to save $100,000 before investing. That was my financial buffer, and enough cash to allow us to upgrade to a house if we wanted to.

By the time COVID-19 hit, my savings were over 50% higher than this goal.

So why didn’t I start investing in shares once I hit my goal?

First of all, because I am conservative with money and wanted to pay off my home loan as quickly as possible. The guaranteed return of paying off my home faster, though a lower return than investing in shares, was at least guaranteed.

Secondly, I’ve always been of the opinion that a crash was coming. If you have a strong conviction that a crash is coming, I wouldn’t invest. For me, it was just a matter of when, not if, a crash was going to happen.

By not investing in shares and instead building cash in my offset account, I’ve achieved the best of both worlds. I reduced non-deductible interest, a guaranteed return for a few years, and have now taken advantage of some tasty shares at a 30% discount to only a few months before.

If I had have invested when I intended to three years ago, all capital growth would have been erased off my portfolio. That would have really stung.

When a crash is coming, cash is king.

The market is nowhere as efficient as it’s reported to be

Throughout the whole crisis, there was a common response whenever new information was received “the stock market has already factored that in”.

When the news said we were headed for a recession…everyone said the market already knew that and factored it in.

When the news said that schools would close…everyone said the market had already factored that in.

Somehow, the market is a mind reader, as are all the participants?!?!

The reality however is this - the market is not as efficient as some believe, and the market is far more affected by sentiment that an efficient market should be.

Bad news tanks the market. So does emotion and uncertainty.

Sentiment is real. Why else would the ASX fall as soon as a bad day on the S&P500 occurs.

Financial planners have it tough

Throughout the whole COVID-19 journey, I kept up-to-date with some financial planner friends of mine.

The truth is, financial planners have it tough.

If you tell a client a crash is coming and they should keep their money in cash, the client sees the returns of the market gets upset with you when the crash doesn’t come fast enough.

If alternatively you invest a client’s funds and the market tanks, it’s your fault you didn’t see the crash coming.

If you accurately predict the crash and got out just in time, the client expects you to do it every time.

Over the long-term we know that history shows that this just isn’t possible.

Perhaps the best quote to come out of the COVID pandemic for me was this:

“Clients want all the returns of the market with no downside risk”.

The truth is this, financial planning is a tough business. Clients want to see action, but sometimes the best course of action is no action at all.

As a client, are you prepared to accept that?

Or do you want to only pay someone when you see them constantly working for their pay?

Nobody knows when the top is, but with a little experience, you should be able to get pretty close

It’s well established that no one can accurately predict the top of the market. Likewise, no one can predict the bottom.

However, if you know what to look for, you should get some pretty good indications of what’s to come.

An extended bull market is a sure sign something is coming.

If you have your ear to the ground, you would have also seen an increase in closing businesses, vacant premises (no income for the landlords), slowing construction.

When your mate at the BBQ starts saying a recession is coming, you know sentiment is low. (PS don’t listen to your mate at the BBQ, just use his opinion as an indication of what everyone else is thinking).

I also look for lessons from those that have been before. If Warren Buffet is holding cash, it’s probably because he is hedging a crash and looking to pick up stocks on sale.

Staggered buying on the way down

Because it’s extremely difficult for anyone to pick the bottom of the market, doing staggered buying on the dip is a good way to get into the market.

I bought into the whole ‘the market has already factored that in’ BS. I went a little too hard too early, thinking the market had already achieved the lowest point.

Learn from my mistakes.

Identify the total amount you want to spend, and start buying tranches as prices decrease.

Better yet, wait until you start to see some increase in price growth. You might miss the bottom but at least it’s trending upwards instead of further down.

Be prepared in advance of the crash

My complacency caught me out. My ideal tax structure was to purchase shares in my Family Trust.

However, 7 days since applying, I’m still waiting for my share trading account to be set up.

In the meantime, I’ve ended up buying shares in my own name.

My complacency has created a future tax issue - the dividend income will be taxed in my name and I won’t have the flexibility of distributing the income the way I would with a Trust. Further, at some point in the future, I will want to transfer my shares to the Trust, therefore triggering Capital Gains Tax if the shares have increased in value.

The good news is that the amount invested wasn’t overly substantial, and because it’s just me and my wife, the income probably would have gone to me anyway. So I can live with the mistake, but it’s still annoying I didn’t take the time to prepare in advance.

When preparing for the crash, it’s also important to have studied your potential investments prior to the crash. Become familiar with a selection of stocks, and use that knowledge to predict how they will weather the storm. Try not to stray from the stocks you have researched.

Most people have no spare cash and businesses aren’t much better either

Other than a handful of people and Bill Gates, not many people could have predicted the devastation the COVID pandemic has caused.

I use to tell clients their businesses should have 6 months worth of expenses saved up in case of an emergency.

After years of everyone telling me that was impossible, I started reducing the target to 3 months of expenses saved instead.

They told me the same thing! It’s still not possible!!

Having a war chest of cash is a priority and your business may one day depend on it.

The best way to build the war chest is to put aside a proportion of your profit every week so that the cash builds over time. As your revenue grows, so should your war chest. Yes it might be hard to save $100,000 all at once, but over a few years it is very achievable.

If this sounds familiar, it’s just paying yourself first. Just do it for your business!

While 3 months of savings may not be enough to save all businesses, everyone would have felt a little more confident if they had an extra $100,000 in the bank.

Get serious about protecting your business. We may not experience another event like this again (let’s hope not), but there will always be something else to challenge business owners. Cash alleviates the stress.

So there it is, a few key lessons from the ongoing COVID pandemic saga. I'm confident there will be many more as this pandemic unravels.