by Andrew Sivertsen, CFP®
It has been roughly eleven years since stock markets bottomed out in March of 2009.
As the economic expansion continues, each new major headline naturally leaves investors wondering if this will be the event that triggers the next major market downturn; will it be a viral outbreak, trade wars, or elections?
The reality is that no one knows and statistically 2020 is no less or more likely to have a major market downturn than there was in 2019. Where does that leave the average investor? There are several simple steps you can take to prepare yourself for the next financial crisis.
Ensure Adequate Reserves
There is an age-old investment principle that simply states “buy low and sell high.” During a market downturn, investors typically want to avoid selling stocks if possible. How much money do you have in savings, money markets, or CDs? While these funds typically yield a very small rate of return, their purpose is not long-term growth—it’s to protect against the unforeseen. If stock markets took a larger downturn, a retiree with healthy reserves could reduce their portfolio withdrawal and live off their reserves while they wait for a market recovery.
For most people, 3-6 months’ worth of short-term investments is adequate. Some retirees or workers in commission-based businesses prefer up to 12 months. Consult your advisor at The Planning Center to determine what’s best for you.
Understand Your Risk Tolerance
Before anyone invests, they need to understand their inherent risk tolerance. Every person grew up with a different understanding and relationship with money. That makes each person unique in that there is no one-size-fits-all approach to investing.
People react differently to negative market news and could potentially make harmful long-term decisions based on short-term reactions. Fortunately, there is a lot of academic research from psychologists in the field of behavioral science that can help guide us in determining how much financial risk investors can take. If you haven’t done so in a while, perhaps it’s time to review your risk tolerance profile with your advisor to make sure your downside risk is not more than you can tolerate.
Review Your Investment Allocation
Once you have a handle on your risk tolerance, it’s time to review the overall risk of your portfolio. Are you in a financially appropriate place based upon your age and goals? Younger investors can typically invest more in the stock market, as they will have the time to ride through many market downturns between now and retirement. In fact, many are already contributing to retirement accounts. For young investors, a market downturn provides a great opportunity for them to buy more shares of stocks or mutual funds while share prices are down. Retirees, on the other hand, are a different story, as they are probably living off the proceeds of their accounts.
The average retiree has about half of their money in the stock market and half in safer assets. Your allocation is important for the next market downturn. Historically, it’s taken about 1-3 years for stock markets to rebound after a major downturn. During that timeframe, we want to limit the amount of stocks that we sell. Let’s say, for example, an investor has one million dollars in a retirement account, of which half was in safer investments, and they need $50,000 each year. In this scenario, they would have ten years of distributions set aside in safer assets. In your next meeting with your advisor, consider reviewing your asset allocation. In particular, look at how much your allocation would have gone down in the years 2008-2009. Could you withstand that drastic a drop in your portfolio or is it time to get more conservative?
Look Past Headlines and Let Systems Work
Once your reserves and portfolio are in a healthy place, the next step is to simply live your life. The Planning Center has multiple systems in place to monitor at short- and intermediate-term volatility. In addition, the markets are regularly scrutinized for larger market dips – to buy more shares when investments are down and sell shares when necessary to protect your portfolio for the next downturn. We’ll take a deeper dive into these systems in future articles.
The media clearly has a bias to focus on negative news, as this strongly holds consumers’ attention. Try to limit how deeply you get drawn into news stories centered on bad financial news. It is completely normal to experience anxiety and stress during a major financial downturn. Going for walks, journaling your daily gratitude, and spending time with other people are all great ways to relieve stress and anxiety. Know that your Planning Center advisor is well-trained and ready to talk with you should you feel the need. We are here for you. Call on us.
Andrew Sivertsen, CFP®, is a Sr. Financial Planner in the Quad Cities office of The Planning Center, a fee-only financial planning and wealth management firm. Email him at: firstname.lastname@example.org.