Could the Stock Market Crash? While It May Not Happen Immediately, Here’s How to Prepare
Although the stock market keeps marching higher and higher, at some point the market will eventually drop, so plan how to react now … before it actually happens.
Don’t worry, no need to stop and check your stock, real estate and cryptocurrency investments to see what is going on. Rest assured; all is well. The Federal Reserve is still supporting financial markets by providing enough liquidity to fill up the Pacific Ocean, government officials are fine-tuning another stimulus package measured in the trillions of dollars, and corporate profits look like a Space X launch headed to outer space.
But many investors I speak with who are retired, or near retirement, are worried about a possible crash. One retiree went so far as to liquidate all of his stocks a couple of months ago and invest everything in gold and silver. As the market just keeps marching higher, so have his worries.
Unfortunately, an investment decision like this can harm a person’s emotional and financial health. Because of his decision, he was likely to begin rooting for bad news – even chaos in the markets. He said he just wanted to be safe and, of course, would get back in the market later. He simply couldn’t eliminate the emotions he was feeling and focus on the diversified plan we had built designed to serve him well when, not if, the market turns south.
One lesson the financial markets have taught us is that the only guarantee is change. Understanding your investments and how they will perform during a downturn is the key to weathering any storm. Much like the COVID-19 pandemic sparked a downturn in early 2020, another downturn will occur at some point. Here is how to be prepared and the actions that can be taken now.
Wealth Accumulators – Embrace it
For individuals who are many years from retirement and still accumulating wealth, the answer is simple: Embrace a possible bear market by saving aggressively now. Maintaining a consistent investment strategy though periods of steep market declines has historically been the quickest way to recoup losses and enhance long-term investment returns.
For example, it would have taken an accumulator with a $100,000 portfolio leading up to the 2000 or 2008 stock market crashes nearly seven and five years, respectively, to recoup the losses from those devastating events. However, had they continued to save $20,000 each year the time period drops closer to five and two years, respectively.
Although it can be uncomfortable to watch your net worth decline during a downturn, recognizing that there is no need to withdraw any portion of your investment portfolio for years should allow you to focus on the better investment opportunity that has surfaced.
Stock prices will be at a certain level when you reach retirement. Nothing you can do today will change that. However, your rate of return from now until that point in the future is a function of the price you pay for the stock today. So, paying lower prices when the market has tanked will create higher future returns for new money that is invested.
If You are Approaching Retirement, Prepare Now
Once a person is set to begin withdrawing from their investments, instead of contributing to them, a different mindset should be adopted. Now risk management becomes a higher priority than the growth of your capital. One reason for this strategy is that no one – I want to repeat – no one can time the market.
If you are in this soon-to-retire group, begin to prepare now, both financially and emotionally, for an inevitable major market decline at some point in the future. One way to do this is to begin adding assets to your portfolio that are less volatile and ideally have a low correlation to riskier stock and real estate investments. These could be corporate and government bonds, certificates of deposit, money market funds or alternative assets — any financial asset that has a minimal chance of loss over a three-to-five-year time horizon.
Failure to put in place a well-thought-out financial plan as you enter this stage of life could result in a major adjustment during retirement.
One client who is within five years of retirement has been extremely comfortable making his portfolio more conservative over the prior year due to his past experiences. He has vivid memories of two family members, one who retired around 2000 and the other around 2008 – both before major market crashes.
Neither person took steps to adjust the risk in their portfolio to be in line with their tolerance leading up to these events. Adjusting their portfolios afterward resulted in losses of hundreds of thousands of dollars. He recounted numerous instances of mental and physical anguish due to their financial situation quickly turning south right after they retired. It paralyzed them for years, resulting in countless dreams and vacations that never happened due to this lack of planning. Let this serve as a warning to make sure you are comfortable with the risk level of your portfolio, especially for all who are in this stage of life.
The Standard & Poor’s 500 index has delivered only one year of negative returns during the past 13 years, creating a sense of complacency among investors. Accordingly, I believe many older investors have portfolios much too aggressively invested in stocks and other risky assets to hedge against a possible repeat of the 2000 and 2008 crashes. For the person willing to forgo the potential for higher returns in exchange for increased safety, consider switching new investments in later years to more conservative assets.
It’s common that the final two or three years of employment are those where savings are highest for just about everyone. Proper financial planning can determine when this occurs, allowing you to save for multiple years in more conservative investments – and easily reach the right asset allocation goal by the time you retire. However, be sure to always keep a modest stock allocation, since stocks have historically been the best asset class to hedge against long-term inflation.
If You Are Already Retired, Lean Against It
For those people already retired, there is no doubt a major market crash will be uncomfortable. The good news is if you followed both steps above you should be able to utilize our final strategy to navigate a sharp downturn. By reducing your stock allocation as you enter retirement, you now have a cushion to handle a downturn when the stock market takes a big hit.
When the stock market crashed last year in the early days of the COVID-19 pandemic, many retirees got their first real taste of fear in over a decade. Watching a portfolio decline so sharply in such a short period of time with all the uncertainty surrounding the economy justifiably causes fear.
As a result, the number of calls from clients increased dramatically. Although we routinely reminded them that no adviser has a crystal ball and cannot possibly predict how any downturn will play out, they had peace of mind knowing there was a plan in place no matter how long the downturn lasted.
In this case, while their stock investments were down sharply, much of their bond portfolio held up much better. After the market tumbled, we asked each client to consider how long it would take them to spend all of the money they have invested in bonds during their retirement. This exercise allowed them to fully understand we already had a plan to maintain their current standard of living even if the pandemic lasted for years. It’s because we didn’t necessarily have to sell any of their stock investments to pay the bills for an extended period of time.
Today, when clients call about the possibility their stock market gains could evaporate quickly, we simply have the opposite conversation. We are trimming their allocation in stocks to meet their withdrawal requests instead of bonds. This is what we refer to as “leaning against the market” and should be a core strategy of a retiree’s withdrawal strategy.
No matter your current situation, this blueprint should help you understand how to set up your long-term investment strategy. Regardless of why the stock market suffers its next major decline, the strategy will be a function of controlling your emotions and executing the plan as outlined above based on where you are in your stage of life. Having a plan in place and following it is the best ways to get through the next crash – and do so without losing much sleep. Good luck!!
About the Author
Director of Portfolio Management, McGill Advisors, a division of Brightworth
Jeff Harrell is a wealth adviser and director of portfolio management at McGill Advisors, a division of Brightworth. Jeff graduated from California State University at Sacramento with a degree in Business Administration (Finance Concentration). He formerly worked at London Pacific Advisors as a research analyst. Jeff obtained his Chartered Financial Analyst designation in 2003. He is a member of the CFA Institute and the CFA North Carolina Society.