For most of 2019 the stock market did nothing but go straight up. Then August happened.
During the first two weeks of the month major market indexes like the S&P and DOW fell by up to 8% from market highs set the previous month, followed by an up and down pattern that put many retirees on edge.
Investors worried about a slowing worldwide economy, trade wars with China, and concerns about an inverted yield curve. On the other hand, the U.S. economy chugs along at a better than 2% GDP rate, inflation remains super low, and other economic indicators point in the right direction.
Instead of fretting about the next big meltdown, I recommend this easy 3-step strategy for retirees worried about losing money in stocks.
Step #1, Focus on facts. A few facts to consider include…
- No one can predict short term swings in the market or foretell the direction of the economy. The truth is no one, not me, not your rich friend, not Warren Buffet, not the pundits on CNBC or talk radio or anyone else can tell you with any certainty what will happen in the stock market over the next year or two, not to mention the next month or two. Remember, their comments are opinions, not facts.
- Markets fluctuate and eventually recover. Most of the time the recovery can be measured in weeks or months. Occasionally, it’s measured in years and rarely it could be a full decade or more before stocks reach new highs. But eventually the market always recovers. The key is to be able to survive financially until the recovery comes without having to sell stock positions while they are down.
- Major market sell-offs almost always precede a recession. Corrections of 10% or even 20% happen all the time. In fact, most calendar years see at least one market decline of 10% or more. Most people can deal with that. It’s major bear markets that experience losses of 20% and more that strike fear into the hearts of investors. Fortunately, bear markets are relatively rare and they almost always start about six to twelves months in advance of a recession. As long as the economy is growing, the market will generally follow.
- Risk is real. When stocks rise people often feel they can take on more risk. What is there to worry about? “Stocks are hot!” Your true tolerance for market volatility shows itself when markets fall. If you’ve been having trouble sleeping this month, now may be a good time to review your portfolio to see how much your retirement accounts could decline in a bad market. Your financial advisor can help you determine your exposure to stock market declines and create a plan to deal with it before it happens.
- The best time to act is always before the #$%@& hits the fan. Right now we are NOT in a recession, but who knows how things may look a year from now? Trade wars, geopolitical events and a 2020 Presidential election will only add to the uncertainty.
Taking action now while markets remain near all-time highs may be wise. You could miss out on some market gains if you act early, but once the market drops 20%, 30% or more, you might as well wait it out. The time to do something has passed.
Step #2, Assess your risks. If a 50% decline in the value of your retirement account will push you off the ledge, you may want to reduce your exposure to stocks. Most bear markets suffer losses of 25% to 35% and last a year or more, but in extreme conditions stock markets can lose 50% or more of their value in a short period of time and last for much longer. (Think: 1973/1974, 1987, 2000 – 2002, 2007/2008).
All of my clients have a risk number that represents the amount of their losses and gains in various market conditions.
Using this information, we can make a judgment on how much risk is too much based on their comfort level and proximity to their goals.
If your portfolio has more risk than you are comfortable with, now may be the time to take action to reduce your exposure to stock market risk. Talk to your financial advisor about how vulnerable your investments are to stock market risk and make changes as appropriate.
Step #3, Build a cash reserve to pay your bills for 5 years. This is really the secret sauce that will save your soul then next time the market goes down and stays down for a long time.
Here is how it works:
- First add up how much money you need (in todays dollars) to meet your financial needs. Maybe that’s $5,000 in monthly expenses.
- Next, add up how much income you receive every month from pensions, Social Security and other reliable, consistent sources. Let’s say that adds up to $4,000.
- Do the math. The difference here is $1,000 per month that you will need on top of pension and Social Security income to meet your monthly expenses in retirement. Multiply that number by 60 (12 months x 5 years) and you have the amount of money ($60,000 in this example) that you need to set aside in boring, safe, interest bearing investments to meet your monthly income needs regardless of what happens in the stock market over the next 5 years. If you are more conservative, do the math for up to 10 years.
Of course, this doesn’t mean you won’t see fluctuations in your account values over this time. It just means you have enough money set aside in a safe cash reserve to meet your needs during difficult market conditions without requiring you to sell your stock investments to pay the bills.
For most investors, retired or otherwise, the right portfolio balance depends on your stomach for market risk, time horizon and other factors. There is no way to completely avoid stock market declines and also get a reasonable total return on your long-term savings.
The key is to strike a balance that meets your needs and allows you to get through the tough times, and to do it before tough times come.
To review your portfolio and create a retirement income plan that gets you through the next market decline contact me at 651.379.3935 or email me email@example.com
If you are a client, we will review your financial plan, update your risk profile and discuss any next steps. If you are not a client, we would love to provide a second opinion and discuss the benefits of working with a trusted advisor who can help you create a retirement income plan that meets your needs.
The views expressed are not necessarily the opinion of Royal Alliance Associates, Inc. Due to volatility within the markets mentioned, opinions are subject to change without notice. All Investing involves risk including the potential loss of principal. No investment strategy including buy and hold and diversification can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary and therefore this information should only be relied upon when coordinated with individual professional advice. This information is not to be taken as investment advice or a guarantee of future results.