The Emotional Impact of Economic Change
Headlines about economic changes, particularly those involving tariffs, can trigger strong emotions among investors. The uncertainty surrounding trade policies and inflation can lead to fear-driven decision-making, which can be detrimental to long-term financial health.
Many investors are asking: How will recent tariffs impact my portfolio?
While no one can predict the future with certainty, we can look at history, evaluate risk, and take practical steps to help prepare for our financial future.
Here are three key steps to help you navigate this uncertain landscape:
- Examine historical data on tariffs and their impact on markets.
- Stress test your investment strategy and update your financial plan.
- Resist the temptation to time the market.
Let’s break down each of these steps in detail.
Step 1: Understanding the Historical Impact of Tariffs on Markets
Tariffs—taxes imposed on imported goods—have been used throughout history as a tool for economic policy. While their goal is often to protect domestic industries, they can also have unintended consequences for the broader economy, including stock market volatility.
Historical Examples of Tariff Impacts:
- Smoot-Hawley Tariff Act (1930): This legislation raised U.S. tariffs on over 20,000 imported goods, contributing to a severe decline in global trade. Many economists believe it worsened the Great Depression.
- Steel and Aluminum Tariffs (2018): Under the Trump administration, tariffs on steel and aluminum imports led to increased costs for U.S. manufacturers. While the S&P 500 initially declined, the market rebounded after companies adjusted to the new costs.
- China-U.S. Trade War (2018-2020): Tariff escalations between the U.S. and China caused volatility in global markets. However, long-term impacts were mitigated as companies adapted their supply chains.
Key Takeaways:
- Markets often experience short-term volatility when tariffs are introduced, but they tend to stabilize over time.
- Diversified portfolios historically fare better during tariff-related disruptions.
- Investors who stay the course instead of reacting emotionally tend to see better long-term results.
Step 2: Stress Test Your Investment Strategy and Financial Plan
One of the best ways to prepare emotionally and financially for challenging economic situations is to stress test your retirement plan and your investment strategy. This process involves assessing how different market conditions, including a tariff-induced correction, could affect your portfolio. Stress testing can approximate what would happen to your portfolio historically if some initial factors were to change. In other words, you can see how your probability of success would have changed.
While incredibly helpful, stress testing can be difficult for DIY investors. Most individuals don’t have access to the tools that finance professionals use to stress test portfolios.
At One Life Financial Group, our clients have access to software that can stress test their plan for different scenarios. It can help answer questions like “What would happen to my investments if:
- The markets dropped immediately by 20%-30%.
- Social security was reduced or went away?
- Inflation was higher in the future?
- Health care costs increased?
- I live longer than planned?
Below is a sample analysis showing how a hypothetical client’s probability of success would change under different circumstances:
By proactively reviewing your financial plan, you can help continue to ensure that your investment strategy aligns with your long-term goals, regardless of short-term economic shifts.
Step 3: Avoid the Temptation to Time the Market
When faced with uncertainty, many investors feel the urge to adjust their portfolios in an attempt to “time the market.” However, history shows that this strategy rarely pays off.
Why Market Timing is Risky:
- Missing the Best Days: Some of the biggest market gains occur within days of major declines. Investors who panic and sell often miss these rebounds. Click here to read more about how costly it can be to miss just 1-5 of the best market days during the year, and here to read more about why you might not want to try to time the market.
Over the last 20 years, 77% of equity funds and 92% of fixed-income funds failed to survive and outperform their benchmarks after costs (source). If you are trying to time the market, you have to guess right twice. Once about when to get out and once about when to get back in to the market.
- Emotional Decision-Making: Fear-based investing leads to erratic decision-making, which can erode long-term returns. Market volatility and media headlines may tempt investors to make irrational and costly moves in their portfolio based on fear. However, reacting emotionally to volatile markets may be more detrimental to portfolio performance than the drawdown itself.
Click here to read more about what you can do if you are feeling worried or stressed about stock market volatility.
- Historical Market Resilience: Despite economic disruptions, including tariffs, markets have historically trended upward. Click here to view a graphical representation of the S&P 500’s historical prices.
A Smarter Approach: Stay the Course and Plan for the Long Term
Economic changes, including new tariffs, can create uncertainty in the markets. However, historically, investors who abandon their long-term strategies in response to short-term market fluctuations have seen their portfolios decline.
For instance, in 2023, the average equity fund investor lagged behind the S&P 500 by 5.5%. Investors who stay disciplined, stress-test their portfolios, and resist emotional decision-making tend to achieve better outcomes.
Will Inflation Due to Tariffs Hurt My Portfolio?
Inflation is another major concern for investors, as tariffs can lead to higher costs for imported goods, which may contribute to overall price increases. However, history suggests that moderate inflation is not necessarily detrimental to well-structured portfolios.
A look at equity performance in the past three decades shows no reliable connection between periods of high (or low) inflation and U.S. stock returns. In fact, equities have historically outperformed inflation over the long run, as shown below.
While tariffs may contribute to inflationary pressures, strategic asset allocation, and long-term planning can help mitigate potential risks.
By following the three steps I’ve outlined in this post, you can navigate uncertainty with more confidence and keep working toward long-term financial independence:
- Examining historical tariff impacts
- Stress-testing your strategy
- Avoiding market timing
Finally, taking a proactive approach to your financial plan will help you weather short-term disruptions and remain focused on your long-term financial success. That’s why we utilize a Proactive Wealth Management Process at One Life Financial Group. If you’re interested in what that looks like for our clients, please click here to view our Annual Proactive Wealth Management Calendar.
If you’re still worried, don’t hesitate to pick up the phone to call your advisor or to schedule an initial consult with One Life if you would like to create a plan that can help you secure your future, even during difficult times. Our 90-minute consultation is always at no cost to you!
If you are a One Life Financial Group client, click here for instructions on how to run different scenarios and gain a better understanding of the strength of your plan or contact your advisor for assistance. If you are not a One Life Financial Group client, please get in touch with us to schedule a no-cost consultation to discuss your concerns.