We all know it’s coming, but we just don’t know when.
Late one afternoon, after the financial markets in the U.S. close for the day, we will all see the news headline and get that tight feeling in our stomachs:
“Dow Jones Industrial Average Plunges 1,000 Points,” screams the headline. Or maybe a lot worse. Maybe double that amount. And so it begins, another sharp decline in stock prices, which if it drops 20 percent or more from its peak will be officially labeled a bear market.
Everyone who invests in stocks, or nearly any other investment for that matter, knows on an intellectual (mind) level that markets go up and markets go down. Bear markets are a normal part of the investing cycle. On an emotional (heart) level, however, bear markets can be gut-wrenching and fear-provoking. That’s especially true if you are a retiree, or someone nearing retirement, with your IRA, 401(k) or other retirement portfolios at least partially funded by stocks. Your financial future, your retirement income, your security, are at stake. No wonder your stomach is in knots and your heart is beating a bit faster.
For reasons I explained in a previous story, “6 Reasons Retirees Need Not Fear Bear Markets,” it isn’t wise to simply pull all your money out of stocks when the markets turn negative. When people tell me how much money they lost in the last bear market, I remind them that they only lost money if they panicked and sold at the wrong time. I won’t repeat all of the points here from the previous article, but some of the key takeaways that are relevant for this discussion are these:
- You (and me and everyone else) are not smart enough to consistently time the markets and know when is the best time to pull money out AND put money back in.
- Bear markets don’t last forever, and so far, 100 percent of the time, stock prices have recovered and eventually soared to new heights following all previous bear markets. That doesn’t prove that this pattern of performance will continue into the future, but 100 percent of the time is a pretty impressive track record.
- The long-term historical performance record of stocks is so superior to the long-term returns from bonds and cash investments (like bank CDs and money-market savings accounts) that it would be a big mistake to not have a portion of your retirement portfolio in the market. Once again, past performance is not necessarily indicative of future results, but we have a lot of stock market history that can be analyzed and compared.
If pulling all of your IRA or 401(k) money out of stocks and hiding it under the mattress isn’t the best idea for your retirement portfolio, even in uncertain times (and which times are NOT uncertain?), then what are prudent steps a retiree, or someone a few years away from retirement, should take to prepare for the next bear market?
As someone who has been following the market for nearly 40 years and spent part of my career professionally advising clients about their investments, let me offer the following recommendations. At the least, taking these steps now will lower your anxiety a bit when the next bear market strikes.
Step 1: Make sure you own the right stocks
Not all stocks are created equal. The high-flying stocks you might have favored as a young professional are probably not suitable now that you are approaching retirement or already retired. This is not the time of life to take big chances or search for the next Apple or Facebook stock. Stick with tried and true companies, which are often described as “blue chip” stocks. If your stock mutual funds or ETFs in your IRA or 401(k) are described as “emerging growth” or confined to a single sector such as technology or energy, then you would be wise to exchange them for more conservative managed or indexed portfolios that favor larger, more established, growth-and-income stocks. Your financial advisor can help you assess whether you own age-appropriate stocks or not.
Step 2: Keep your stocks diversified
Never, ever bet all your money on one, two or three stocks, even if they are companies you worked for and have confidence in. Diversification is one of the most important rules when it comes to investing. While the overall stock market has done well over the longer term, individual companies rise and fall. Experts don’t agree on how many stocks it takes to have a diversified portfolio, but 20 is a good number since it means you won’t have more than five percent of your stock portfolio tied up in any one stock. If owning 20 or more stocks seems too much of a burden, then invest in mutual funds or ETFs instead of owning individual stocks. These portfolios often include 50 to 100 stocks. Good diversification is more than just the number of stocks. You need to diversify across industries. Your portfolio isn’t diversified if it consists of 20 utility stocks.
Step 3: Re-balance your portfolio
Diversification also means spreading your money among different types of investments, not just stocks. Most retirement portfolios will include a mix of stocks, bonds and cash investments — or mutual funds that invest in those categories. A typical strategy is to divide your money by percentages, such as 60 percent in stocks, 30 percent in bonds, and 10 percent in cash. That’s just an example and may not necessarily be the best asset allocation for you; talk with your financial advisor about what formula suits your needs best.
Over time, however, the original split in your portfolio gets distorted, requiring you to periodically re-balance your portfolio. In the example above, what if the 60 percent of the portfolio invested in stocks grows at double the rate of the bonds and cash? Before you know it, the balance has shifted so that 75 percent of your portfolio is now in stocks, more than you are comfortable with. Re-balancing your portfolio back to the original 60-30-10 allocation is a disciplined, sensible way to manage your risk. This is especially important after a long bull market, when stocks have risen significantly in value.
Step 4: Keep some cash handy
If you are retired and taking income withdrawals from your IRA or other retirement accounts, now may be a good time to raise the amount of cash you hold in your portfolio. When the next bear market strikes, you don’t want to be forced to sell shares of stock (or stock mutual funds) at low prices to generate retirement income. Instead, have enough cash (CDs, money markets, treasury bills, or very short-term bond portfolios) available to withdraw for income, leaving your stock portfolio intact. A good rule-of-thumb is to keep enough cash in your IRA to fund at least two years worth of income withdrawals. That will help you withstand the next bear market.
Step 5: Build a solid long-term plan and stick with it
Once you have built a solid, diversified, age-appropriate retirement portfolio, stick with it. Don’t let scary headlines or market drops rattle you. Don’t be distracted by those self-appointed “geniuses” on Facebook or on the radio who claim to know how to outsmart the markets and keep you from ever losing money.
If you take this article’s advice, it’s true that your portfolio’s value will still fall during bear markets, as economic and market cycles do their thing, but keep your focus on the longer-term objectives and stay the course. This is an endurance race, not a sprint. You will do well in the longer term.
Let me offer one final word of advice, and it may be the best tip of them all. Stop reading the financial news and tracking your portolio’s value so often. Build a solid retirement portfolio using the five steps in this article, use the best financial advisors you can find who seem to geniunely have your best interest at heart, and then stop worrying about it. Enjoy your life. Spend time with the grandchildren. Volunteer for your church or community. Bear markets and scary times will come and go, but over time, your retirement portfolio will be just fine.
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