8 Things To Do When You’re Worried About The Stock Market
December 28, 2018It’s been a rough ride lately in the U.S. markets. As I write this, the S&P 500 index fell about 5.8 percent during a short trading week, leaving investors feeling jittery. Part of the yield curve inverted, which means that short term interest rates are higher than some longer term interest rates. Is the powerful bull market we’ve had since the Great Recession beginning to wind down? If so, what should you do to prepare?
Whether this is normal volatility in a market that has room to grow or the beginning of the next economic downturn, recent events are a reminder that financial markets don’t go up in a straight line. Eventually, we’re going to have a bear market because that’s how the business cycle works. Over my adult lifetime, I’ve seen plenty of market bubbles and busts. Consider your worry about the market a sign that it’s time for a check-in on your investments.
1. Measure returns from where you started, not from the highest balance
It’s a natural tendency to look at the highest number on your 401(k) or brokerage account statement and then feel like you lost money when the statement balance is subsequently lower. You feel like you were counting on that sum, and now it’s not there anymore. Unless you sold at the exact moment when your balance was the highest, however, you wouldn’t have realized the gain, so it’s not very helpful to measure that way.
How did you do against your goals?
A more realistic approach is to measure your success vs. your goals. Has your account balance grown since you originally invested the money? Did you require a certain average annual rate of return or that your balance grow by a certain amount by a certain date to fund your goal?
What’s your progress so far? Are you trying to match or beat a benchmark using one or more market indices? (See Why Is An Index Important In Investing?) If you’re saving for a house down payment or an early retirement, and you’re still on track to meet that goal, that’s what matters – not whether you’re down 10 percent from the all time high.
2. Run a retirement projection
For most of us, funding a future retirement is a primary reason we’re investing. Now is an excellent time to run an updated retirement calculator to check your progress, given your savings and reasonable projections for your rate of return and inflation. You can use the Retirement Estimator for a basic check in to see if you are on track. You can also use the calculator to model different scenarios using different rates of return to see what happens.
Make sure you’re using a reasonable expected rate of return
When updating your retirement projections, it’s better to use a conservative expected rate of return. Research from the McKinsey Global Institute suggests investors lower their expectations for average annual US stock returns to 4 to 6.5%. If they’re wrong about it, you’ll be happily surprised, but if they’re right, you’ll be adequately prepared.
3. Check your risk tolerance
Try downloading our risk tolerance and asset allocation worksheet or use the questionnaire from your brokerage firm or retirement plan provider. Compare the results to your current portfolio mix. If they line up, you may not need to re-balance your investments. If there is a big discrepancy between your current investment mix and your ideal one, you may want to make some changes.
Know the difference between risk and volatility
One note about “risk” and “volatility.” Risk is typically measured in portfolio management by standard deviation. The more spread out daily prices are from the average price – either higher or lower — the higher the standard deviation of an investment.
If it were just math, it would be easier to stomach the volatility. But it’s your money! When most people think about risk, they think only about the downside risk – the risk that they’ll lose money and not be able to achieve their goals.
Try putting a dollar number on your risk tolerance. How much would you be willing to see your portfolio value drop in the short run before you’d throw in the towel? For example, if you need $50,000 in ten years to take a sabbatical, would you be comfortable seeing the interim value of your account drop to $45,000 (a 10 percent drop) in return for the possibility of a ten percent gain? How about $40,000 (a 20 percent drop)? If the thought of seeing your balance temporarily drop to $40,000 causes you indigestion, then maybe it’s time to lower your stock exposure.
4. Rebalance your portfolio if needed
Rebalancing back to a target mix of investments helps you keep the level of risk in your portfolio stable by taking some profits from those investment types that grew faster in value and buying more of the investment types that didn’t grow as fast or fell in value. Think about rebalancing as buying low and selling high.
Once you’ve re-checked your risk tolerance and run projections to see if you’re on track to meet your goals, you may or may not need to make some changes in your investment mix:
Examples of rebalancing:
- If your current investment mix reflects your goals and risk tolerance, you probably don’t need to rebalance. For example: you’re planning to retire in 22 years, have a moderate risk tolerance and you’re in a 2040 target date fund.
- If your investment mix is out of whack with your target mix, rebalance. During the past decade, many investors have become overweighted in stocks due to strong stock market performance. If your goal is to maintain 60 percent in stocks and you’ve got 80 percent in stock funds, it’s time to rebalance and move 20% back to bonds.
- If your risk tolerance has changed and your target investment mix is different than before, that’s also a very good reason to rebalance.
- If you’re within 5 years of retirement, consider building up a much larger cash position. In pre-retirement years, it’s generally a good idea to move at least 3 years of anticipated expenses to cash-type investments (think savings, money market funds, CDs, etc.). That way, if the markets are in a slump when you retire, you won’t have to sell investments at a loss to pay your bills and can wait for a market recovery. Make sure you’ve updated your risk tolerance. Many pre-retirees find that they want to take a lot less risk in their investments during the transition to retirement.
Not sure of the best ways to rebalance your portfolio? See 4 Different Ways To Rebalance Your 401k.
5. Put together a simple investment policy statement (IPS)
You may also find it helpful to put together a brief, written outline of your target investment strategy to use across all your accounts. An IPS doesn’t have to be fancy. Just set some targets for types of stocks, bonds and other investments (like real estate or commodities) that you want to maintain over time. See this Investment Policy Statement Template for some ideas and/or dive deeper here: Morningstar Course (free): Creating Your Investment Policy Statement and Investment Policy Worksheet.
6. Diversify
Are your investments as diversified as they could be? Diversification mixes different types of investments so that the gains of some investments offset the losses on others. That reduces risk (although doesn’t eliminate it). Different types of investments historically have delivered gains at different times – think U.S. stocks vs. international stocks or stocks vs. bonds.
If you’ve got a “plain vanilla” portfolio, consider the pros and cons of incorporating different types of investments to reduce volatility. Many investors are just in the S&P 500 index, for example, or only in stocks and bonds. If it fits your risk tolerance and goals, incorporating some non-correlating investments like real estate, commodities and hedge fund proxies (e.g., market neutral funds, managed futures, long/short funds, hedge fund ETFs, etc.) can help reduce risk and smooth out returns.
7. Build up your emergency cash
You may not know when the next recession will hit, but you can still be prepared. Recessions don’t just bring bear markets. For some people, they also bring layoffs. If you don’t already have 6 months in living expenses in an emergency fund, work to build up that account.
8. Take advantage of volatility IF you’re aggressive
Are you a hands-on investor with an aggressive risk tolerance? Periods of high market volatility also present opportunities, but only for those who are comfortable with the financial equivalent of skydiving. There are new ways to “trade volatility,” including volatility ETFs, futures on the VIX (the volatility index) and options on market indices. My husband, Steve, spent time this past week using his mighty math powers to successfully trade volatility ETFs. I’m not that hands-on, nor am I that much of an aggressive investor, so it’s not something I’d do myself.
What’s the bottom line? Recent market volatility is an alarm clock reminding us that it’s been a great bull run, but there may be some roller coaster times ahead. Make sure you’re buckled in.