How Will Wealth Architects Help Navigate a US Default?
We agree with the client’s observation: there is no shortage of material on the whats and whys. For those interested in an explanation of the debt ceiling, we recommend this link. Please note: whenever possible, we try to keep partisan politics out of our commentary. Unfortunately, the debt ceiling issue is squarely partisan. We understand that not everyone will agree with some of the points made in the link, and that’s OK! We chose the link not because, as a firm, Wealth Architects endorses every statement, but rather because we feel the attached piece covers the salient points.
On to the client’s question: What will we do if we anticipate a default?
Step 1: We Will Not Panic
If the US defaults, things will be bad. There’s no way around it. But we will not panic. We will remind ourselves that, even in the recent past, we have faced very bad things. Since Wealth Architects’ start in 2005, we have helped clients through many difficult times, including: the financial crisis of 2008, the US fiscal cliff and first default scare in 2011, the 2013 Greek default, Brexit in 2016, COVID in 2020, a contested US election in 2021, and the 2022 Russian invasion of Ukraine.
For those clients that have been with us for most or all these difficult times, you may recall our advice has been essentially “things may feel bad now, but this too shall pass. Trust the financial-life plan that, together, we have designed specifically for you to weather good times and bad.” You may also recall that, each time, things did get better. Regardless of how bad we felt along the way, markets eventually recovered. The chart below shows a global stock index and a global bond index.¹ We can see that, since Wealth Architects’ inception, global bonds have more than held their value – even after last year’s bond bear market – and global equities have more than tripled:
Step 2: Consult Your Financial Plan
As your fiduciary, we believe that a well-constructed, long-term plan is key to financial success. Together we develop your financial-life plan based on your unique values and goals. When things get difficult, as they certainly will be in the case of a default, we strongly recommend turning to your plan. It’s meant to be your “North Star”, providing light and guidance in even the most challenging circumstances. Moreover, your financial-life plan is not meant for good times only! The plan assumes that we will face bad times and, thus, we don’t recommend changing your plan merely because things may get tough in the short run.
That said, we recognize that plans change over time. If your circumstances have changed, or you’d just like to talk things out to ensure your plan remains relevant in light of these potential events, please let us know.
Step 3: Make Certain You Have Sufficient Liquidity
When markets are volatile, as we’d expect following a hypothetical default, we strive to avoid forced selling of equities. We thus want to ensure you have sufficient liquidity for your short-term needs. For most clients, this will mean little or no changes: your financial plan expressly contemplates short-term needs and establishes a mix of stocks, bonds, and cash. We understand, however, that circumstances change. If you are aware of material upcoming expenses, or simply would like to review your current reserves and liquidity in advance of any event, please let us know.
Step 4: Wait and Observe
A major US default is unprecedented. In our opinion, default could lead to a wide array of short- and long-term outcomes for both stocks and bonds. We simply don’t know what will happen. In 2016, for example, when the UK voted to leave the European Union (the “Brexit”), global stocks dropped more than 5% in one day. Most observers – including us – assumed we were in for a protracted downturn. Merely three weeks later, however, global stocks returned to their pre-Brexit levels and ended the year more than 4% higher.²
In 2011, the last time we faced a potential US default, the Standard and Poor’s rating agency downgraded US debt for the first time ever. Investors responded to the uncertainty by… buying more US treasuries. The prospect of a US default created uncertainty in the markets. Uncertainty prompted a flight to quality. That flight, in a highly ironic move, led to higher prices for US treasuries.
The 2008 financial crisis was the worst we’ve faced since the Great Depression. Unlike the two situations above, we did not face a quick turnaround. Even so, domestic stocks, dividends reinvested, regained their pre-crisis high in less than five years.³ Investors who faced their fears, taking advantage of what turned out to be a generational buying opportunity, likely saw their account balances return even more quickly.
We don’t mean to suggest that a US default will result in a short-term turnaround. It may be as bad or worse than we fear. But we simply can’t tell, ex ante, what’s likely to happen where, and to what extent, for either stocks or bonds. In our opinion, making radical changes to our globally diversified portfolios or plans to “get ahead of the markets” can lead to surprising results that may not help us reach our goals. Instead, we will wait and observe how the global markets process the information and trust that broad diversification is our best ally.
Step 5: Embrace the Uncertainty
We expect markets to be volatile leading up to and in the event of a default. We also expect some investors to engage in panic selling of both stocks and bonds regardless of their underlying value. This can create opportunities for those with a long-term perspective. We are reminded of the (perhaps apocryphal) quote by J.P. Morgan: “In bear markets, stocks return to their rightful owners.” As difficult as it may be, we are likely to recommend buying some stocks and bonds, at lower prices, to help keep your portfolio in line with the strategic asset allocation designed to meet your long-term financial goals.
Step 6: Keep Talking
We place great value on building trusted relationships. Although bear markets can be extremely challenging, we believe they provide an opportunity to strengthen our relationship with you. As our CEO Mark Johnsen recently noted: “It’s when adversity emerges that one may get unnerved and tempted to change course.” We understand the natural reaction and desire to “do something” to help reduce or avoid the uncertainty. In our opinion and experience, however, those who resist that temptation tend to be more successful long-term investors.
Trust is built on communication, so let’s keep talking. As noted above, if you would like to review your financial-life plan – or just talk about what’s going on – please don’t hesitate to let us know. We are here for you, in good times and (especially) bad. We greatly appreciate your trust and, indeed, look forward to helping you navigate difficult markets en route to living a wealthier life, regardless of whether we face a default in the near future.
¹ The MSCI ACWI captures large and mid-cap representation across 23 Developed Markets (DM) and 24 Emerging Markets (EM) countries. With 2,884 constituents, the index covers approximately 85% of the global investable equity opportunity set.
DM countries include: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, the UK and the US. EM countries include: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.
The Bloomberg Global Aggregate Total Return Index measures the performance of global investment grade fixed income securities. This index is widely used as a benchmark for fixed income securities.
All performance or returns presented are for informational purposes only and do not represent the returns of any actual accounts and are presented for informational purposes only. Hypothetical performance or returns are not indicative of future returns and should not be relied upon as a guarantee of future results. All investing involves risk of loss, including the possible loss of all amounts invested.
² Source: Morningstar and Wealth Architects.
³ Domestic stocks represented by the S&P 500 Index. Source: Ibid.
The information provided in this commentary is intended to be informative and not intended to be advice relative to any investment or portfolio offered through Wealth Architects. The views expressed in this commentary reflect the opinion of the author based on data available as of the date this article [essay] was written and is subject to change without notice. This commentary is not a complete analysis of any sector, industry or security. Individual investors should consult with their financial advisor before implementing changes in their portfolio based on opinions expressed. The information provided in this commentary is not a solicitation for the investment management or other services offered by Wealth Architects. References incorporated into the report [essay] from third party sources are as of the date specified and are believed to be reliable. Wealth Architects is not responsible for errors in the third-party data.