Market Corrections: Preparing for the Inevitable

Despite recent volatility, the current bull market has lasted almost nine years. Many people are asking, “How long will it last?” Nobody knows the answer. Market downturns are inevitable. How can you prepare for the inevitable? That's a hard question to answer for everyone.

The Least Loved Bull Market

March 2009 brought the bottom of the Great Recession. Since then, the Dow Jones Industrial Average rose from a low of 6,547.05 to a high of over 26,000. However, it has been one of the least loved bull markets ever. Non-stop news and political turmoil have certainly cast their shadow. (For more, see: Why a Stock Market Correction May Lead to Overreaction.)

What are the concerns? Naturally, many surmise the bottom is going to completely drop out at some point. In reality, there is some truth to markets having negative years. In fact, 27% of the time the S&P 500 is negative. As you can see from the chart below, most downturns last under a year. The really bad ones though can linger for a couple years. But they are few and far between.

Understandably, if you are relying on retirement income from your investments, when one of these drops occurs it is reasonable to be very concerned. What is the solution?

Review Diversification

For starters, sit down and review (preferably with a professional) your objectives. If you are in or close to retirement, it’s important to solidify diversification between different asset classes. This will lessen the impact any one sector can have on your portfolio. Remember, retirement is about maintaining, not finding, the next hot thing.

Determine Risk Tolerance

Once you’ve affirmed your balance, decide on your risk tolerance level. Although the stock market has a permanent trend upwards, the road there is winding. It is important to recognize what volatility you can or cannot handle. The biggest mistake people often make when investing is acting on emotion rather than logic.

Align Portfolio With Risk Tolerance

Now that you have a properly diversified portfolio and it aligns with your risk tolerance, what next? Make sure you have the appropriate amount of assets in the more secure asset classes (bonds, etc.,) to last you through a downturn.

For instance, let’s say you have $1 millionportfolio and need $50,000 a year from it to live. Determine how many years of cushion you’d like in that secure bucket. If you’re answer is 10, you should have $500,000 in more secure asset classes. This makes sure you have enough dollars in the less volatile assets for drawing income when the stock markets are down.

The Bottom Line

One of my favorite quotes from one of the world’s greatest investors of all time Peter Lynch is: “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

The important thing here is to position yourself not to sell stocks when they are down. That effectively assures a loss. When I’m asked, “Should we take some of these proceeds and take them off the table?” My answer is inevitably, no. We are positioned to withstand any downturn, typically. Why play the guessing game? If you asked around, no one would have been able to predict a 20% year in the markets in 2017. Those that tried to outsmart the system invariably missed out. (For related reading, see: The Greatest Investors: Peter Lynch.)