A lot of finance consists of very educated people being shocked when something that’s consistently happened for hundreds of years happens again.
– Morgan Housel
Leading up to 2022, there had been 26 bear markets since 1929, and we’re currently working our way through number 27. That works out to a bear market, on average, every three-and-a-half years. You’d think with that frequency, people wouldn’t be surprised when one happens, but as the quote above accurately describes, a not-insubstantial number of “experts” move quickly from denial to surprise to alarm roughly every 42 months (a much smaller percentage stick to the belief that a bear market is always just around the corner).
Given that the experts were surprised that something happened that happens pretty regularly, the wisdom of trusting them to tell you how to navigate the downturn is pretty suspect. So what should you do, especially if you’re near retirement and don’t have time for your portfolio to “bounce back”?
If you have a plan, rocky markets don’t have to mean disaster. Here are some key ideas to consider.
Timing The Markets Doesn’t Work
Markets are constantly in flux, and typically, those instabilities aren’t too extreme, making it fairly easy to stay the course.
But every now and then, that’s not the case as 2022 has demonstrated.
When the market hovers at either extreme, it’s challenging not to adjust your investments – particularly because markets tend to nose dive as the rest of the world seems off-kilter. Self-preservation may warn you to sell when you should stay invested or go “all-in” if everyone else seems to have identified a winner.
Study after study – and the real-world experience of many investors – has shown that timing the market is not a sound, long-term strategy. A big reason for this is that when you time the market, you have to be right twice: selling before the market drops too much and getting back in before it rises too far.
Otherwise, you risk earning below-market returns, and the market’s tides can turn rapidly.
Even missing the market’s 10 best days can result in lower returns. Since 2008, the 10 best single days produced an average return of just over 8%. Think of the long-term consequences missing those days could have on your retirement portfolio.
Instead, building an investment plan that prioritizes long-term returns and balances risk along the way is beneficial.
But what does “long-term” mean when investing through a bear market?
While we don’t know the future, we can look to the past for guidance. There were 12 bear markets of varying lengths and severity. In the 12 bear markets between 1946 and 2020, on average, it took 12 months for the S&P 500 to hit bottom from when it peaked and another 21 months to climb back to that previous high point.
So using the recent past as a guide, you’d need to tide yourself through three years on average as the market went from high to low before moving on to new highs.
Prepare Your Portfolio With Plenty Of Stress Tests
If we look at history and keep those three years in mind, how can you invest in ways that help you resist the urge to adjust to the market? You need to position your portfolio for a bear market ahead of time.
When building a portfolio, make sure to include relatively conservtive investments that can serve as ballast, and assess how your portfolio might respond to different scenarios.
An excellent test is assuming you’ll encounter a bear market in the first few years of retirement (the analysis is a form of sequence-of-return risk). This is a practical test because from a timing perspective, it’s a worst-case scenario. Early in retirement you’re no longer saving, so a downturn isn’t an opportunity to buy securities at bargain prices. At the same time, you’re not well into your retirement at which point – assuming you planned well and invested according to plan – you’d find yourself with plenty of cushion to weather a downturn. Since a sharp downturn at the onset of a retirement is usually the worst-case, if you construct a plan that can handle that downturn, you’re very likely in good shape for the entirety of retirement.
Your overall allocation – the mix of stocks and bonds you have – will play a key factor in how your portfolio is likely to perform in a bear market. Beyond the allocation though, having a cash cushion can also be a significant help. If you have cash, you can draw from that bucket if the market dips and avoid the need to sell investments.
What If You’re In Retirement When A Market Downturn Strikes?
If you’re already a few years into retirement, the good news is you may have passed the critical early period. But that doesn’t necessarily mean you’re in the clear, and it definitely doesn’t mean you’ll stop worrying about considerable drops in your account balance.
Market downturns can be particularly stressful for retirees who need the income from their savings to support their lifestyles. Again, be sure that you’ve stress-tested your portfolio beforehand so you can quantify the effect a bear market has on your retirement security.
Stress testing has the secondary benefit of allowing you to understand just how much your portfolio could drop in a bear market so you can make adjustments if needed. Even if you don’t make adjustments, a good stress test can help you avoid being caught off guard when a bear market happens.
Although you shouldn’t time the market, after a sharp market drop, you can be intentional about where you take your withdrawals from. One strategy is leveraging additional resources like cash and safe fixed income when equities are down. Building this safety net and having the correct mix is essential to carry you when bear markets emerge.
If you have enough of a cushion in your budget, you could look to decrease discretionary spending. By withdrawing less, you leave more of your investments to bounce back.
The key is to have a focused plan you can turn to instead of turning to CNBC or the latest headlines in Yahoo Finance. If you do, knowing your plan was built to withstand the turbulence can help you sleep well at night.
Focus on the Details and What You Can Control
Bear markets are so tough because at first blush, there’s not much you can control and the future is murky – after all, when things are bad, it’s easy to assume things will get worse. And even though most investors “know” that selling is the wrong thing to do, we are by nature driven to do something (thanks, amygdala!).
At times like these, instead of making decisions under stress, take a step back and consider the following questions:
- Is the current downturn within the bounds of what I planned for? How does the downturn in my portfolio compare to the worst case scenarios in my plan?
- Does my plan continue to look viable given the downturn? How much cushion do I still have?
- How long can my more conservative investments that haven’t dropped much (or at all) in value cover my expenses while I wait for the market to recover?
- Do I have other sources I can draw from, like cash reserves or home equity, that I can replenish when the market recovers?
- Can I cut back for a bit on discretionary spending?
All of the above can help return a sense of control to you if you’re retired or about to retire and need to draw on your portfolio. If you’re not retired, it might be worth considering increasing your investments since a sharp market downturn leads to long-term bargains
If you don’t have a plan that includes bear markets, you should consider putting one in place. Perhaps the biggest benefit of constructing a comprehensive financial plan is that you may not have to do anything when the market drops because you’ve already accounted for it. That idea by itself should provide immense relief.
Lastly, you’re not alone! We’re here the help and can guide you from start to finish.
Set up a time to discuss how your portfolio may react to a bear market.