The last time US stock investors experienced a bear market (typically defined by a 20% decline in the broad stock market), Barack Obama had just been elected President, and the Billboard Top Artists chart included names like Kid Rock and the Jonas Brothers.
Undoubtedly, a lot has changed in the world since then. For example, the S&P 500 has ripped upwards more than 300%, and there haven’t been many bumps along the way. There’s no way of knowing exactly when this ride ends, or how bad it gets when the wheels fall off. However, there is no better time than now to make a plan of action for when the next bear market wakes up from its hibernation. As John F. Kennedy put it, “The time to repair a roof is when the sun is shining.” Here’s a few tips to help you get your investment house in order.
Assess Your Current Market Risk Exposure
If you have half of your portfolio invested in stocks, and the other half in bonds, and held that portfolio without making any changes from 2009 through 2017, you’ve had a rate of return of about 10% per year. However, about 90% of your returns came from your stock investments. Not only that, but your portfolio is significantly weighted more heavily towards stocks (more than 70%), meaning your market risk is a lot higher today than it was back in 2009. It’s a good idea to get in the habit of “stress testing” your portfolio. If the stock market were to decline by 20%, do you know approximately how much your portfolio would be drawn down by? It’s impossible to predict, but using modern portfolio theory, you can get an idea of your current market risk exposure. Does it align with your financial goals and risk tolerance? What, if any, changes should you make to your portfolio before the next bear market occurs?
Create a Written Plan of Action for When the Bear Market Happens
DALBAR* releases studies analyzing investor behavior and the impact it can have on portfolio returns. As a matter of fact, in the 30-year period ending December 30, 2016, the S&P 500 had an average annual return of 10.16%, while the average stock investor had an average annual return of just 3.98%. There are a lot of causes and factors going on here, but a recurring them among investors is buying high and selling low, which is a recipe for disaster. It’s easy to think you’ll make the right decisions when the next market crash comes along, but sticking to that plan is another story. Studies show that writing down a plan of action can lead to greater long-term success, whether it be a personal goal or an investment plan. For example, say the market moves down 20% over a 10-week period. What’s your move? Do you hold on to your funds and resist the urge to sell everything? Do you take some of the funds that have been sitting in cash and buy more stocks, thinking that they’ve “gone on sale” and are a good bargain? What if stocks continue to decline even further? Come up with a plan of action, and revisit this over and over. Write things down and be able to justify your actions. When the market decline does happen, pull out your plan, take a deep breath, and execute.
Don’t Try to Time the Market
For the most part, it can’t be done. At least not consistently over extended periods of time. There are the Warren Buffett’s, David Einhorn’s, and Peter Lynch’s of the world, but we would argue they are the outliers. Many mutual fund managers have to live in the “monthly” or “quarterly” results-driven world, as they have bosses and shareholders to answer to. The average investor saving or in retirement has the luxury of time on their side. Bear markets are a reality, and something that investors need to accept. However, you can control how you react, and you can control (to a degree) the amount of market risk in your portfolio. Getting a handle on the things you can control is far more important than whether or not your portfolio outperformed the Dow Jones Industrial Average.
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The views expressed represent the opinion of Modern Wealth Management an SEC Registered Investment Advisor. Information provided is for illustrative purposes only and does not constitute investment, tax, or legal advice. Modern Wealth Management does not accept any liability for the use of the information discussed. Consult with a qualified financial, legal, or tax professional prior to taking any action.
* http://www.dalbar.com/ DALBAR, Inc. is the financial community’s leading independent expert for evaluating, auditing and rating business practices, customer performance, product quality and service. Launched in 1976, DALBAR has earned the recognition for consistent and unbiased evaluations of investment companies, registered investment advisers, insurance companies, broker/dealers, retirement plan providers and financial professionals.