When the financial clouds are gathering, you have some preparations to make. No. 1: Reduce your risk.
Before a natural disaster hits, there are usually warning signs you shouldn’t ignore. We saw the value of preparation last year during the devastation of Hurricane Harvey and Hurricane Irma.
People worked to protect their homes and families, whether it was to install hurricane shutters or stock up on supplies. In some cases, after doing everything possible to minimize potential damage, the sensible and safe strategy was to get up, leave the area and then assess the situation once the storm had passed.
We can draw some parallels to the way your investments are managed for retirement.
Wall Street’s next bear market will likely resemble a hurricane. It’s slow moving. It’s trackable. It has characteristics that can be clearly defined. We don’t necessarily know when it will hit, but we can rely on history to provide some clues and predict its course.
Preparation and education are everything. This isn’t like a tornado, which quickly appears and causes unanticipated damage. Not only do we know that hurricanes are coming, we actually have enough time to name them! We are able to make reasonable predictions about when they could hit and what kind of damage could occur.
If you are a retiree — or getting close to retirement age — it’s essential to identify these financial storms and how you should react.
The bear market in 2008 was devastating to vulnerable investors, so it’s sensible to seek safety and protection. Yes, the sun will shine again, and it’s great living on the water during prosperous times. But if you’re a retiree, the priority is protecting yourself.
What if the financial storm doesn’t hit? What if it turns in a different direction and you could have made some serious money by staying aggressive? That’s second-guessing. The key is having a sound strategy in your investment portfolio, staying disciplined and avoiding a disastrous scenario.
Like I tell my clients, we’re not here to get you rich quick. We just want to make sure you don’t become poor! So what to do?
Here are a few tips:
- Seek protection. This should always be the priority. Being unnecessarily aggressive can do great damage. So, you must take steps to protect yourself, your family and your valuables. By reducing your exposure to risk in the stock market — or sometimes completely getting out of the stock market in extreme situations — you protect the things that are most important. Money markets or short term bond funds can be an excellent choice as a temporary parking place during these types of turbulent times.
- Stay disciplined. Is it difficult to see more aggressive investors making bigger money when you are staying on a more conservative track? Of course. But don’t lose sight of your plan.
- Do the math. Let’s look at the example of a million-dollar portfolio. If you experience a 50% loss, you’ve got to earn 100% on the remaining portfolio just to climb back to even! Is that kind of risk really worth it? If you’re taking out a 4% withdrawal in retirement, that’s an annual $40,000 out of your million-dollar portfolio. If your nest egg is cut in half as a result of unnecessary risks, then a $40,000 annual withdrawal is now 8% of your total account. The stock market has produced about a 5% return on average in the past 17 years. So now you’re going negative every year. More than likely, you’re going to run out of money before you run out of life.
- Consider the worst-case scenario. If you’re too aggressive and the market goes south, what does that do to your lifestyle? You might be forced to return to work. You might have to live primarily on Social Security income. You might have to do a reverse mortgage. None of these is a good alternative, and that’s why we preach a defensive, risk-first approach to our clients.
You’re always going to have people who are more accepting of risk. They can psychologically deal with a loss of 40% to 50%. But that’s not advisable for anyone nearing retirement.
When the market is good, there’s a lot of enthusiasm and interest in taking risks. But when the market turns bad, you hear people saying, “I didn’t know it was going to be like this. I didn’t think it could be this bad.” Don’t let that be you.
You have put in a lot of work over 30 or 40 years to accumulate your nest egg. Now it’s about keeping it productive, so you can maintain the income you need for the rest of your life and your spouse’s life. You shouldn’t take foolish risks, because the next bear market could be one of the largest bear markets we’ve seen.
Sometimes, this means not getting the maximum return from the stock market. That’s OK as long as you’re reaching your goals. It’s not about getting to your destination the fastest. It’s about getting there safely and on time.
There are factors to watch right now. We are stretching the boundaries of what is historically considered a reasonable stock price versus the underlying profits and earnings. When you see a sign like that, it’s like the winds picking up. It should get your attention.
We’ve been fortunate to have historically low interest rates. But as interest rates rise, economic growth can slow, and the stock market usually follows that trend. A recession almost always precedes or partners with a bear market.
When you see storms brewing, you need to be aware. Just like the protection you obviously must have for your home in a hurricane, you need to protect your financial portfolio. By taking these cautious steps and working with your adviser, you can help ensure the safety and security everyone wants in their retirement years.
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