How is your portfolio doing? If you are like most, you have seen some nice gains since the last bottom which was back in March 2009. You might be thinking that this can’t go on forever…and you are right. We are now in the second-longest bull market expansion that we have ever seen. This means that we have not seen a 20% pullback since the Great Recession when the market tumbled more than 50% from October 2007 to March 2009.
So will we see another drop? The answer is an absolute yes. I just can’t tell you when it will happen. I also don’t expect a correction any time in the near future, but I know we will see one at some point.
Should that scare you? Not really. That is the nature of the stock market. It can go up more than what its historic average gain was and it can then drop in value which gets us more in line with what we think are “market returns”.
What should you do to prepare for the next drop?
Understand how much you would lose if we experienced another 50% drop in the stock market or an almost 9% drop in bonds as experienced in the late 70’s. How much you lose depends on your exact investment mix. For today’s purposes, let’s assume that you have a diversified portfolio of stocks and bonds. Using a tool that we use in our Financial Planning software, here is the estimated loss for several different portfolios.*
80% Stocks/20% Bonds 38% loss
60% Stocks/40% Bonds 25% loss
40% Stocks/60% Bonds 11% loss
Now, knowing what you could potentially lose if it happened again, be honest with yourself and answer this question: how would you feel? Most of us would feel crummy. It would no longer be fun to look up our account value, and watching the news would become even more stressful than it currently is. Some of you might even say that you would be excited about finding some buying opportunities…but you are a rare breed.
Ask yourself another question. What would you do? Would you take any action? I remember someone telling me during the 07-09 market that they felt they needed to do something. They felt responsible for their family and said sitting back and doing nothing did not feel like a good option for them. They had to sell. This was not the best decision for them. If he had stayed in the market with a diversified portfolio he likely would have seen everything recover and then some.
My question for you is what would you do? If you think you would just feel bad but not go in and start selling, the current mix in your portfolio may be suitable for you. If, however, you don’t think you could make it through the heartache of seeing dollars vanish into thin air, you may want to think about making a change which could potentially lessen your losses should we see another down market.
Another factor that you should consider is when you will need the money. You don’t ever want to be put in a position of being forced to sell investments that are down. Whatever stage of life you are in, you need to think about always positioning assets so that you have enough in more conservative vehicles to cover anticipated needs from your portfolio. For example, for our retired clients we set up a bucket of money in fixed income securities, which is relatively more stable than the rest of their portfolio anticipating covering their income need for up to 10 years. This may help us avoid being forced to sell stocks in a down market**. If you will need money from your portfolio in the next 3 years you should consider reducing the risk for those assets.
Make a change if you need to. Most of you will go through these questions and decide that you do have your investments positioned properly and while you won’t necessarily enjoy a downturn, you understand how markets work and are willing to accept that things go up and down. However, some of you may have decided that you cannot mentally take another correction or you may have figured out that you need to access your money sooner than planned. In either case, this may mean that you need to make some changes. Of course, I suggest speaking with your advisor. Make sure you think about things like tax implications before making any moves. Work on reducing the amount that you have in risk assets like stocks and increase the amount in more stable investments like bonds and cash.
Hopefully you will be better prepared for the next drop. It has happened before and will happen again. For most of us, it will occur multiple more times in our lifetime.
Want some help with your overall financial plan? Go to http://doingmoneyright.com/cbc to set up your FREE, one-on-one, Confidence Booster Call. Byron W. Ellis, CFP®, CLU®, ChFC®, CRPC®, is a CERTIFIED FINANCIAL PLANNER™ professional and Managing Director of United Capital Financial Advisors, LLC, a Financial Life Management firm. The information contained in this article is intended for information only is not a recommendation, and should not be considered investment advice. Please contact your financial advisor with questions about your specific needs and circumstances. The opinions expressed herein are those of Byron Ellis and not necessarily those of United Capital Financial Advisors, LLC. * Depending on the composition of the portfolio, the worst bear market is either the “Great Recession” or the “Bond Bear Market.” The Great Recession, from November 2007 through February 2009, was the worst bear market for stocks since the Great Depression. The Great Recession Return is the rate of return, during the Great Recession, for a portfolio comprised of cash, bonds, stocks, and alternatives, with an asset mix equivalent to the portfolio referenced. The Bond Bear Market, from July 1979 through February 1980, was the worst bear market for bonds since the Great Depression. The Bond Bear Market Return is the rate of return, for the Bond Bear Market period, for a portfolio comprised of cash, bonds, stocks, and alternatives, with an asset mix equivalent to the portfolio referenced. The loss shown is: 1) either the Great Recession Return or the Bond Bear Market Return, whichever is lower, and 2) the potential loss, if you had been invested in this cash-bond-stock-alternative portfolio during the period with the lower return.
** Equity investing involves market risk, including possible loss of principal. Diversification doesn’t ensure a profit or guarantee against loss. In general the bond market is volatile, and fixed income securities carry interest rate, market, inflation, credit and default risk. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.